Three weeks in the watering holes of the Arizona, New Mexico, Colorado, and Utah mountains, at the height of lowlands summer heat and the monsoon storms, is a treat. So you may not hear from me until late in the month. I am not bearish generally, and I have tried gradually but persistently to reduce volatility in my overall portfolio in all the ways I have described in the Portfolio Ideas section, and still capture upside gains. But I won't be watching the markets very closely if at all, even though I just upgraded to the new Sidekick 3 from TMobile which is such a delight compared to lugging laptops around. I can slip it in a pocket and I can do 80% of what I could do on a laptop or desktop computer.
But I do see some grounds for caution if one is aggressively long. A four point triangle under new high points (see the 1-2-3 in back numerals ) can be a failure point early in a bear move. Also the May/June decline was steeper and deeper than any we've seen since 2004. There are powerful resistance lines above which I have labelled "EL" from a mentor/teacher I had in the 1990's. And tomorrow there is a time line for change of trend from another teacher of mine.
I am not wanting or trying to be short, just a bit more hedged because of vacation and the TA concerns. I use a combination of BEARX and RYTPX which are short funds of two different types. In a rather low volatility total portfolio I am about 1/3 hedged in addition. As with health and car insurance I hope my paid premiums for this insurance are wasted.
"As a nation of baby boomers nears 60, an army of financial planners from Sacramento to Scituate have mobilized to guide their clients out of equities and into bonds in an effort to offer them income and stability; and why not? History is on their side. Income-oriented investors have enjoyed a secular bull market in bonds over the last 25 years. Over that time period, the 10 year Treasury rate dropped from 14.0 percent to 4.4 percent. Inflation in 1981 was over 12%. Now after flirting with deflation 5 years ago, it is comfortably situated below 3%. Clearly, the last 25 years have been favorable for bond investors. All told, a portfolio of long-term bonds returned to investors a compounded annualized return of 11.8% over that period; clearly a competitive alternative to equity investing at the time."
"What's the likelihood that the next 25 years will match the last 25? The answer's easy: zero. Investment return has just as much to do with the entry point as it does with the exit point."--Jack Ablin, CIO, Harris Private Bank, Harris Outlook, May/June 2006.
Think about 1981 to recently: inflation rates down, interest rates down, oil prices down, gold down, GDP growth rates down, wage growth rates down. Remember the deflationary crash of 1981-82 and the slow melt down and terminal crashes from 1996 to 1999 and 2000-2003?
Then look at what's happened: oil prices and gold bottomed in 1999 and there was inelastic supply to meet marginally increasing demand. Other commodities or crude goods also began making 2-3 decade bottoms. The long bond rate bottomed in 2003. GDP growth rates in the US and elsewhere began returning to rates not seen since the 1960's and 70's. Despite debates on how inflation is measured, everyone agrees it has risen.
This is the same 25-30 year half cycle which Kondratieff first described in the 1920's. Read his short and simple paper in English translation. http://www.geocities.com/deuxsous/KLW.html It is a 50-60 year cycle of business, interest rates and prices. There is no pessimistic "summer-fall-winter-spring" crash and burn message from Oswald Spengler or his modern "perma-bore" (L-V Gave) followers.
Kondratieff is a simple cycle of supply and demand whose top completed in the 1970's in final oversupply at the end of several decades of price and interest rate increases. Then came several decades of the opposite, when supply and prices and rates were run down, and now that is done too, and we're going up once more.
For several years I have increasingly looked at long term portfolio management as my main investment activity. I do still like to trade short term in stock index futures (S&P500 ES and Russell 2000 ER2 primarily) or in index or sector ETF's). But I have reduced the size of that account and its activity.
As recently as five years ago I would trade an account greater than 25% of total investable funds, but I am now down to ~5%. I only trade that account now when I want to or when I have very strong convictions. Partly this is simply a normal function of "life progress" as my wife calls getting older. :) Although I have been fortunate as a trader, one certainly can't afford to lose a lot as one gets older since there is a lot less time to make up big losses. And if one has been fortunate in investing and working, one has the time and money to travel or do other things than sitting in front of a trading screen all day and all week.
Down-sizing or retirement planning are other names for this switch which many of my generation will have to learn to cope with as they move from very active business or professional lives to less strenuous activity or actual retirement.
Some of the smartest retired people I know pro-actively planned (redundant) with spouses and/or families to reduce their housing size, re-locate geogrpahically if desired, get debts (if any) paid off, deeply review insurance needs, and revamp and refocus investments as "retirement funds".
I'm no expert on this except for my own case, and it's not my intent to become a guru. Bob Carlson's "Retirement Watch" is an inexpensive 16 page monthly newsletter which is helpful for ideas on all financial aspects of retirement in the US. http://www.RetirementWatch.com
When I got back into the stock market in 2003 I decided to try to pick stock (and bond) pickers rather than individual stocks and bonds. Gradually I had learned about volatility by study of many funds through the many bear and bull markets since the 1960's. If you are young and adding regularly to investments (IRA's, 401k's, etc.) volatility is great because you are investing at different prices over time and your dividends are doing likewise. Also the long term trend over decades is upward unless you choose very poorly. You could just keep it simple and buy a DOW fund or even a total US stock market fund like Vanguard's VTSMX which has extremely low costs of 0.19% per year! You could add perhaps 5-10% of a total international stock fund like VGTSX and 5-10% of a total bond index fund like VBMFX.
If you are in your 20's or 30's you could just let Vanguard do the whole thing for you (KISS) and buy Target Retirement 2045 Fund VTIVX which contains all of the above. Vanguard is just an example, and and other fund families let you do the same things. You wouldn't even have to rebalance your account once a year if you use a Target Retirement Fund, and you could even avoid Peter Lynch's "ten minutes a year" maximum time spent on a good portfolio which he jokingly advised. Just do it! Put in whatever monthly amount you can afford and want to by payroll deduction or bank debit EACH and EVERY month and forget about it. When you eventually get interested in investing you might still want to forget about it and "just let Vanguard or Fidelity do it". :)
Of course, I am well beyond my mid 30's, and retired, and I live off what I invested. Very much volatility could be a killer for my family, but some is still useful and tolerable. See some of my other portfolio posts on this issue. (Other income comes from a real estate investment and inflation protection from gold and collectables.)
In several earlier articles I described some of my thinking and some studies I did of a larger universe of funds eligible for my plan. I did not own all of those funds in 2000 nor in 2003, but I have gradually included many of them and weeded out others. The funds discussed in this article I do now own and in the percentages of total investable funds mentioned, and they are the only funds I now own. This could change in the future, and I mention near the end one possible variation this fund group might take to reduce volatility even further.
I am not an investment adviser and I not not work in the investment industry. Regard this aerticle and this site as a whole as a personal "travel log or diary" in the original sense of a blog.
What I have put together is a portfolio with mutual funds that produces decent income but also decent capital gains with fairly low volatility. Low volatility funds share one or more of these characteristics: 1. Diversification, instead of sector niches or capitalization niches, and may include bonds. Two of this type I use are Dodge & Cox Balanced Fund DODBX and Vanguard's Wellesley Income Fund VWINX/VWIAX. Both are boring grinders with inherently low volatility and low costs 2. A willingess to, and history of, raising cash when the market has raced higher, so that they are more likely to have higher cash balances at highs which is put to work at lows. Two favorites here are Fairholme Fund FAIRX and First Eagle Global, formerly SoGenGlobal. At one point earlier this spring both of these funds had 30% cash! Sitting through a 30% bear marker 100% invested, as many funds do, is not good for long term returns. If you look at total return charts (at FastTrack.com) of these two funds of the cash-raining type, you'll see that they weathered the 2000-2003 bear market with gains, as, incidentally also did DODBX and VWINX. 3. A policy of hedging their longs according to some rational and consistent plan. The Hussman Growth Fund HSGFX does this beautifully. Its portfolio of mid caps and large caps selected for growth is partially or entirely hedged short with index options depending upon market valuation and market breadth. They are NEVER net short, always long, and they make their money on the edge that their own stocks have over the average stock of the index, plus the gains on their options from lower prices and/or the interest rate naturtally included in options pricing. They can also buy options when the market is in their view undervalued, as they did in late 2002 and early 2003. They are not "timers" but value investors. They were up over 15% annually during the bear market when most funds were down substantially. Of course they give up some gains in bull markets due to options costs, since there is no "free lunch" for hedging. But HSGFX is bought for the fact they hedge volatility and still have excellent long term returns.
These five funds together make up my low volatility core which is now 46.3% of the entire portfolio. Hussman is the largest position at 19.2% of the whole portfolio, VWIAX/VWINX is second at 11.9%, and DODBX, FAIRX, and SGENX/FESGX are about 5% each. I have studied these funds in depth for total returns over their entire lives or back to 1987. Month by month total returns with actual portfolio dollar weightings were 10.2% compounded anually from November 21, 2000 (when all fund data became available) to March 12, 2003. From that date until June 16, 2006 the same dollar weighted funds had a total annual return of 15.96%. Both periods were pretty dramatic and volatile, and I think these returns are truly phenomenal. Do look at and compare their total return charts from 2000 at places like FastTrack.net or moneycentral.MSN.com with an index fund like VFINX (S&P500) or NAESX (S&P small cap). Also especially note how much less "wiggle" or volatilitythere is in their daily or weekly line charts.
This 2000-2006 record may not repeat over the next six years, of course. Despite the crash and burn and later recovery in tech and large caps from 2000 on that are so deservedly famous, bonds were rising during much that whole period, and so were international and US small cap stocks which were favored by some of these funds. Nevertheless, intelligent diversification, cash management, and hedging provided a very good volatility cushion and excellent total returns, which 100% index investing 100% of the time cannot do.
In addition to the Core Low Volatility portion which is 46.3% currently, 14.1% is in Vanguard High Yield Muni Bond Fund (VWALX) which has a rather low volatility compared to most bond funds, 2.3% in Hussman Total Return (bond) Fund, and 23% in cash money market funds (VMMXX). So 46.3% is in the Core Funds (with some bonds in VWINX and DODBX), and 39.5% is in cash and specialty bond funds. This is 85.8%, leaving 14.2% which I have split into six "niche funds" which have higher volatility, and which have their own different cycles. But they also have higher longer term returns than the core, in most cases: Vanguard Health Care Fund VGHCX, Vanguard REIT Fund VGSIX, Vanguard Energy Fund VGENX, Vanguard Precious Metals and Mining Fund VGPMX, Vanguard Strategic Small Cap Fund VSTCX, and Third Avnue Value Fund TAVFX.
All but the last two funds are self-explanatory. VSTCX is a new small cap fund modelled on Vanguard's successful "quant fund", Strategic Equity Fund. There are many other excellent small cap funds some of which I owned up until this spring, and this one is just "place holding" for the moment and may get replaced. Third Avenue Value Fund is run by value guru Martin Whitman who deserves to be as famous as Warren Buffet but who is much more modest. If I were in my 20's or 30's I would buy some of each of Third Avenue's funds (value, real estate, small cap, and international) and lock them away with the KISS fund I mentioned far above for younger investors. Go to http://www.thirdavenuefunds.com/taf/ sometime and read the Third Avenue quarterly reports which are most refreshing and educational. They are not as entertaining as Warren Buffett but are of far more value, pun intended.
So these six funds cover the niche sector with normally about 2.5% each of total portfolio for a total of 15%. There is exposure to energy, metals, real estate, health, small caps, and deep value here. These are all areas which I believe will always be important in this phase of the Kondratieff Wave which has several decades to go, but they have distinct periods of ups and downs, rarely all at the same time. Obviously the core funds invest in some of these "niches" themselves by being diversified, but I think a litle extra emphasis is warranted in an inflationary era. This group (with a substitution for brand new VSTCX) did pretty well during the bear market as well as in the bull market since then. I cut these back ruthlessly several times a year to their 2.5% allowances so they do not take over the portfolio and detract from the low volatility goal. This cutting and pruning has been tremendously profitable in the past few years.
So this is the low volatility retirement income and growth fund for stocks and bonds. I am trying to avoid intervening or changing it very much except for pruning or rebalancing at intervals. In my case I have studied market direction or "timing" for many years as a trader, so keeping my hands off the accounts has taken me a while and some conscious effort. :) What I have done on occasion, and have mentioned here over the past year or more, is occasional extra hedging with Rydex or Profunds short funds.
The study I mentioned on the total returns from 2000 top the March 2003 low and from then to June 2006 shows that it may not be necessary to do that extra hedging, even in horrific bear markets such as we had starting in 2000. Nevertheless I also did the same study and included a 14% investment (taken from cash) in Prudent Bear Fund BEARX in 2000 and held until June 2006. BEARX may be a better choice than Rydex or Profunds bear funds as it is not only short what it sees as bad stocks but also long some good ones and is weighted up to 15-20% in gold. By including BEARX in the low volatility core portfolio, the total returns were 16% from 2000-2003 instead of 10.2% and 12.4% instead of 15.96% from 2003-2006. So the power of BEARX is clear. Volatility hedging is a double edged sword and has a cost, but the cost of unrestrained volatility can be far worse for someone living off his or her portfolio. One could, of course, include a smaller portion of BEARX than 14% or try to put it on near the beginning of a bear market and take it off near the end. Given my history of trading I may try the approach of putting on a smaller position of BEARX if my studies show a really great possibility of an approaching bear market. The other way I might use BEARX would be if we were going to travel or rent somewhere away from home for a number of months and didn't want to or couldn't monitor the accounts daily or weekly. This is, of course, "fine tuning" and may be unnecessary given the history since 2000.