There were 2-3 different "allocation" discussions yesterday. One person at 85-15 equities/bonds, another person switching from 60-40 to 70-30.
This allocation only explains a BRIEF amount of the risk you take. A third person posted a link to a web site which suggested the "equity" position determined **most** of the risk a person takes.
This does not give the full story.
If you put 100% of investments into S&P 500 you are taking on way too much risk. All eggs are in one basket analagy. You will probably "beat" inflation by 5-7%, with a fun roller coaster ride on a day like yesterday.
If you put 100% of investments into bonds (bond index, for example), you have all your eggs in a different basket. Your risk is now centered on interest rates, when rates go up, you will probably lose money, (as rates increase, bond prices drop) and you will only beat inflation by 2-4%... probably.
If a person was 85-15. All 85% in S&P 500, all 15% in bond index, they have less risk than a person with 100% in either or, and the returns would probably be ~8-9% annually (beating inflation by ~5-6%).
If the same 85-15 person took the 85% and divided it amongst S&P 500, large cap value, International, small caps and mid caps, then took the 15% and divided it among REITS, short term bonds and money markets, they would have less risk than any of the previosly mentioned cases.
Which takes me to another point. A person can invest in 100% equities, be divided among large, mid, small and international stocks (funds) and have LESS risk than a person doing 60-40 with only 2-3 funds.
If the person doing 100% equities has TIME, the time reduces the risk they take (they have time to rebound from a day like yesterday).
I don't want to tell anyone to go 100% equity (I am 100% equity), but it's possible the person doing 100% is taking on less risk than the investor which uses only 2-3 funds.
All eggs in a similar basket?
February 28th, 2007 at 07:44 am
February 28th, 2007 at 08:44 am
February 28th, 2007 at 08:48 am
February 28th, 2007 at 09:05 am
February 28th, 2007 at 09:11 am
I know I said I am a beginner and don't know a ton but I have strayed from putting all of my money in a particular index - that does seem quite dangerous. I probably need more mid-cap and small-cap stocks - when I have more to invest. I probably do have a lot more overlap than I admitted in the threads but the thing is all of my funds have different purposes and are managed differently. There may be overlap, but in a sense not so much. The funds all behave quite differently. I think you alluded to that in your posts yesterday as well. I do try to stray from too much overlap though - for sure. I definitely understand that further diversification certainly creates a "safer" investing environment, even when heavily invested in sotcks. 100% is too risky for my blood but I have had it recommended to me, a lot in my 20s.
Well thanks for your comments on my blog and threads. & keep the insights coming.
February 28th, 2007 at 10:46 am
I agree staying away from unnecessary fees... but is goal to maximize return or minimize fees? I'll pay $50 more to get that extra .5% of return. Every % counts in the end.
February 28th, 2007 at 11:34 am
Perfomance is always the overriding goal, but you should pay attention to fees as you can often achieve the same type of investment, eg in a similar type of asset classes such as mid caps, say, in a mid cap index fund as you can in a mid cap non-index fund. Higher annual expenses just subtract from your net profit, so they bear watching and weighing against various other variables.
February 28th, 2007 at 12:09 pm
My funds are low cost with T Rowe Price. Cost more than an index, but much less than most managed funds. In addition I KNOW who is picking my stocks (the fund manager). Do you know who chooses the stocks in the S&P 500? I don't. Why do these people choose these companies? According to S&P because they "represent the market", but it's not the 500 largest companies in S&P 500, it's 500 companies which a group of people chose, but those people don't care if I make money, lose money, or die tommorrow. I don't think using people for investments which do not have a vested interest in my success is a recipe for success.
In addition the mid cap stock universe is 600-1000 stocks. I don't need a fund to own all 1000, or even 500 of these to sample, when 100-200 companies in a diversified managed fund do just fine (again, low cost). I want to know about the stocks not chosen to be part of sample, WHY? someone made a choice, but gets to hide behind the "index". I prefer higher accountability.
Add to this that the small cap universe is 2000-4000 stocks, again I don't need a fund to own a sample of these (1500 stocks?) when a diversified fund of 100-200 do just fine (again, low cost funds). Again no accountability for the people which chose which stocks to sample as part of the fund, even though other stocks in the index are not included in the fund.
All those things you read on MPT and EMH are because business majors need to do something to get their doctorate degrees. I hold everyone accountable by day, night and investing (my wife hates that sometimes). I want a person to answer to me.
T Rowe Price has many funds (70%?) which beat the average fund in their class. This is because they have low fees and experienced fund managers.
Compare this to Fidelity, where fund managers change as much as the air filter in my car, or Vanguard which relies on an arbitrary index to choose it's stocks, and I am comfortable with T Rowe Price.
I do agree investors need to avoid sales loads and high expense funds, 12b1 fees and other unnecessary expenses... but not all managed funds are bad funds.
February 28th, 2007 at 03:49 pm
February 28th, 2007 at 06:06 pm
Those were the best funds to the allocation we use (45% large cap, 15% mid cap, 15% small cap, 15% international large cap, 10% international small cap).
we have 20% in growth fund of america and 25% in international, I believe.
One thing to watch for is American funds are sold through sales channels with a 5% load. I would NEVER buy a loaded fund if given the choice.
They have some solid funds, but I don't see enough selections to fill my whole allocation (but they have funds for the key portions of allocation).
March 1st, 2007 at 06:35 am
The best benefit of investing in an index fund is that if you are an inexperienced investor or simply don't have the time or inclination to monitor and track your investments, an index fund will assure that you have a representative sampling of the predominant funds in a given asset class.
I don't believe that even the most savvy portfolio manager has a crystal ball with which he/she can predict the next market turn any better than the rest of us. And since most of us have to earn a living some other way, well, there's only so much time in a day to devote to stock watching.
I guess my feeling is, i'm not greedy, and i'm content to earn a more reasonable return rather than sweat over every quarter of a % point. I'm a buy and hold investor, so index funds allow me to do that.
As far as accountability goes, even the best actively managed fund will not likely beat its respective market index by a very large degree in a down year for that asset class. I'm content to diversify my portfolio so i can capture good years in any given market class, whether it's small cap stocks or international stocks, but both the index fund and the actively managed fund will follow the general upward or downward performance trend for a given time.
March 1st, 2007 at 07:13 am
And I am not "trying" to beat the index. I am trying to take on less risk and come close the indexes performance.
Dividends, value investing and smart decisions all take part in reducing risk.