What's on your Christmas list this year?

Well, if I were to overweight a couple of sectors in my long term portfolio going forward, I would vote for buying into Emerging markets and Energy.

Sounds like performance chasing doesnt it? Might be. Emerging Markets and Energy have been on a tear lately - check out the best performing funds over the last couple of years - you'll see most of them fall into 2 categories - emerging markets and Energy :-).

So why am I putting my money (atleast some of it) on these two in particular?

It looks like over the past few years, the rest of the world is catching up with the US and other developed countries. We are in the process of seeing the often mentioned "Global Economy" really take shape.

In this new global economy, everybody's got a shot. Its not only the big boys that can have all the fun (read the US and other developed nations). Latin America, India, China, Eastern Europe and even Africa have joined in the party and are showing real signs of development and progress ("Real" companies making "real" profits).

IMO, over the long run, Emerging markets have a lot more room to grow and when the next opportunity presents itself, I will be adding to my EM holdings.

As far as oil goes - the falling dollar, a Republican government in the White House (at least until the next election), geopolitical tension in the middle east thats here to stay, increasing global demand, are some of the reasons oil prices will continue their upward trend over the long term.

So the next time oil prices dive a bit, I'm going to get me an energy fund :-)

Ofcourse, these "recommendations" come with the standard disclaimer - be ready for a lot of short term volatility and do not put all your investable assets into oil and emerging markets :-) These should make up only a small part of your portfolio (in my case, not more than 20 percent)

The funds in these categories that I like are

EM

VEIEX - Vanguard Emerging Markets Index (already own this one - will be adding more to it). Its low cost, diversified across the globe and has a great record (more details at Morningstar)

Energy, I am leaning towards

FSENX - Fidelity Select Energy (I dont own it yet but probably will on the next "correction" in oil prices)

Hey, for what its worth - the next time you see gas prices rise at the pump, you can find solace in the fact that at least your energy fund is doing well :-)

Have you gotten your XRAY done yet?

Nope - not talking about the much dreaded doctor's visit that you've been dodging :-)

Morningstar has a great tool (free and you don't even need to register) that gives you a complete breakdown of your portfolio - just feed in the ticker symbols and dollar amounts.

It tells you (among other things)

1) Your overall stock, bond, cash allocation
2) Which countries your stocks are invested in
3) Break up of which sectors your stock allocation is invested in
4) Interest Rate sensitivity of your bond holdings
5) Whether you are large cap, mid cap or small cap weighted
6) Whether your portfolio leans towards value or growth

Pretty cool. Check it out here

I always use the XRay when I need to re-balance my portfolio (to get before and after snapshots) and can say that I've prevented a few broken bones in the process :-)

Commodities anyone?

What asset class does the following?

1) Gives you diversification over and above cash, stocks and bonds
2) Benefits from the falling dollar
3) Benefits from increasing infaltion and rising prices

well you guessed it - commodities. With the dollar on its way down, prices on their way up and global demand for commodities spurred on by red hot growth stories in the emerging markets, desh included, does it make sense to add a touch of commodities to your long term portfolio?

Take a look at the long term returns of the Dow Jones commodity index (^DJC) as compared to the Dow Jones Industrial Index (US stock - ^DJI) and the Vanguard short term bond index (VFSTX). Click on image below to enlarge



Looks like the overall performance of the commodity index falls somewhere in between (that of stocks and bonds). Also, if you look at this chart across shorter timeframes, you can see that commodities have their own cycles of ups and downs and are loosely corelated with the stock and bond cycles, which gives you good diversification.

There are quite a few ETFs and ETNs that track various commodity indices

1) GSG - iShares S&P GSCI Commodity-Indexed
2) DBC - PowerShares DB Commodity Idx Trking Fund
3) DJP - iPath Dow Jones-AIG Commodity Idx TR ETN
4) GSP - iPath S&P GSCI Total Return Index ETN

I'm leaning towards DJP. Its well diversified across all commodities - precious metals, energy, agriculture products you name it and is also tax efficient. Haven't pulled the trigger yet tho.

Comments are always welcome.

A little gambling with play money? Sure!

Once a bulk of your assets have been allocated into a broadly diversified portfolio to suit your financial goals and you are on cruise control - well things can get a little boring. Long term investing if done right SHOULD be boring.

However, IMHO it doesn't hurt to set up a small "play money" portfolio (about 5% of overall asset base) just to keep things interesting. With this play money - you could trade stocks, options, derivatives, heck even buy into Cramer's tips all you want.

I would be lying if I said I didn't get a rush from watching a penny stock that I just bought triple in a couple of days. So go ahead - make a killing on penny stocks and the likes. Trade 'em, short 'em, ride 'em up the hill and speculate to your heart's content.

Just remember to do so with only your play money (money that you can afford to lose completely) and don't get carried away and big headed when you double your money in a couple days. It was probably just luck :-)

Its like eating healthy on weekdays and pigging out on the weekends - gotta have the double cheese burger and curly fries once in a while!

Happy trading.....and if you've got any "hot" picks, leave a comment. I'll check them out too.

Pardon my french, but being a cheap ass helps

Although I tend to regularly splurge on my not so cheap "hobbies" - when it comes to investing, I admit I am the biggest cheap ass around. I simply hate paying for things that don't need paying for (on the other hand I'd gladly be willing to shell out a couple of hundred bucks or more to play a round at Pebble Beach :-)). That's just me.

In the investing world, here are some "unnecessary" costs to watch out for

1) Wire transfer fees, check ordering fees, minimum balance fees - these fees can kill you and for no reason. Set up your banking accounts in a way so as to eliminate these fees. Digital Credit Union has worked great for me in the past 10 years. No minimum fees, transfer fees, free check ordering with direct pay - so on and so forth. If I do really need to wire money, they have low rates. Online banks like Emigrantdirect or Money Market accounts like Vanguard Prime work good too.

2) Trading costs and account maintenance fees - have you compared rates for your brokerage costs? If you buy Mutual funds using a brokerage - a lot of times they will ding you with a fee (and pretty sizable at that). And this gets worse if you are investing a small amount every month (DCA). You can avoid these fees if you invest directly with the Mutual fund companies. Also, watch out for the account maintenance fees that mutual fund companies charge. For example, Vanguard charges a $15 fee for any fund that has a balance of less than $10K. But there is a way around it - sign up for e-statements and they waive the fee.

3) Mutual fund Expense Ratios and loads - These are real killers over the long term. Stay away from high ER and load funds. You can do the math or visit Morningstar to research how high ER/load funds eat into your long term returns - its staggering. Pick no load/low ER funds as much as possible.

So lets raise our glasses to more folks joining the "cheapass club"!

Non Resident Indians and the falling dollar

Non Resident Indians (NRIs) that have plans of retuning to India are obviously concerned about the falling dollar. Just this year, the dollar has fallen by more than 13% (as compared to the rupee) and is still falling.

One has to now contend with India's rising inflation AND the depreciating dollar - that's a double whammy and cause for much concern.

I don't buy the official Govt inflation numbers (neither the US govt, not the Indian Govt). Frankly speaking I don't know how they come up with numbers that are so grossly inaccurate. Govt of India puts inflation at 4.5% (or thereabouts) - that's not even CLOSE to the real number.
And the same goes for the US inflation numbers (under 4%) - have you checked the price of gas and milk lately? Have you renewed your apartment lease yet? Oh I forgot - they don't consider these aspects when coming up with the inflation number - well what do they consider? - sorry for digressing, maybe I should leave this for another post.

OK so coming back to the NRI situation. Interest rates in India are close to 9% for Fixed deposits (10% for senior citizens) - mainly to keep up with rising inflation (which is officially at 4.5% - ha!). Interest rates in the US are around 5% and dropping.

Lets say you are an NRI and have an asset allocation plan that is 60% diversified stock and 40% fixed income (all held in dollars) and you plan on retiring in India. In this portfolio, the cause for most concern would be the 40% (fixed income that is earning 4%-5% in the US). If this is held in dollars, it is going to be tough to keep up with inflation in India (which is a lot higher) and one of the most important goals of fixed income is to AT LEAST keep up with inflation.

So how should you tweak your overall portfolio if you plan on retiring in India?

• Hold your long-term fixed income allocation in rupees in India. That way it will keep up with inflation in India. You can diversify across bank fixed deposits and debt mutual funds
• Also hold the India part of your stock allocation in rupees in India
• Hold the rest of your diversified stock allocation in dollars in US mutual funds

This way, the fixed income portion of your portfolio will fulfill its goal of AT LEAST keeping up with inflation in India. Also, you will still hold a widely diversified stock portfolio (by keeping that in dollars in the US) which you would not be able to do if you moved everything to India. India does not have any "international" equity funds that invest outside of India and you will lose the diversification of your stock portfolio if you pull out everything from the US and invest in India. And you never know, the dollar may come back in the next 10 years - then what?

So to summarize - move your fixed income allocation and India stock allocation to India. Hold the rest (diversified stock) in US Mutual funds. And don't forget to pay taxes to Uncle Sam for the interest that you make from your fixed income allocation in India.

Due credit for this idea should go to some folks over at the R2I Finance forum (link on right nav)

Related posts

Post1 - Rupee and dollar
Post2 - Investing in India - different strategy

Ready to retire? Or trying to figure out when you can?

The pager's been beeping like crazy all night and despite all your hard work you're behind on your projects and your bosses have been giving you a hard time of late - you get up one morning and think to yourself - wouldn't it be nice if I could call it quits today - well can you? How do you decide if or when you can hang it up comfortably?

There are a few ways to do this (some involve running spreadsheets and number crunching)

A relatively simple "back of the envelope" calculation involves the SWR - safe withdrawal rate. It is the rate at which you can "safely" withdraw funds from your existing asset base and meet your inflation adjusted living expenses (without the risk of your assets running out).

A commonly accepted SWR is 4%. A more conservative SWR is 3%.

So lets calculate how much one needs to retire using the following assumptions:

Yearly expenses = E
SWR = 4
Asset base required today = E * (100/SWR) = E*25

So, if you stop earning today and want to live off your investments (assumed to be a broadly diversified portfolio that contains 70:30 stock bond allocation) to support a lifestyle with yearly expenses of $12,000, you would need an asset base (invested assets in today's money) of $12000*(100/4) = $300,000

If you take a more conservative SWR of 3%, your asset base required would be $12000*(100/3) = $400,000

Ouch! Considering my yearly expenses, I think I'd better get back to work......

Assessing your risk profile and rebalancing to it

One of the first steps to building an Asset Allocation Plan is to assess your risk tolerance. What kind of an investor are you? How much of a loss in your portfolio can you live with without spending sleepless nights? Do you have the "courage" to throw more money into the market during a downturn or will you sell in panic?

Be brutally honest with yourself and one certain way to test this is to live thru a downturn (we have had a few in the last 7 years, including the dot com bust in 2000). Think carefully about how it affected you - what was your reaction, what thoughts crossed your mind, did you reach your breaking point, did you break, did you sell in panic, did you buy like Braveheart?

If you can accurately guage your risk profile (believe me, its not easy) you can come up with a very important aspect of your asset allocation plan - the split between your equity holdings and fixed income, or in other words, your stock to bond ratio. This will form the basis of your financial plan and once you decide on it - stick to it no matter what.

For example, I like Larry Swedroe's (author and regular poster at the Vanguard Diehards forum at Morningstar) rule of thumb to determine stock bond allocation. Take your maximum acceptable loss percentage, multiply that by 2 and that should be your stock allocation. Meaning, if the maximum loss you can digest without panicking is 30%, then multiply by 2 = 60%. You should not hold more than 60% of your entire portfolio in equities.

Another rule of thumb is - invest your age in bonds and (100-age) in equities. If you are 35 years old, then hold 35% in fixed income and 65% in equities and adjust that as you get older.

Whatever be the allocation you choose, it is important to adhere to it - that is the only way you can be successful over the long term. And this leads us to the concept of rebalancing.

Lets say you came up with an allocation plan of 65% stock: 35% bonds based on your risk profile and are fully invested as such on Jan 1 2007. In Dec 2007, you look at your portfolio and you see that because of the continuing bull market in equities, your equity % of your total portfolio is now 70% and bonds make up only 30% of your portfolio. This would be a good time to rebalance - meaning make changes so as to bring your allocation BACK to 65% Stock : 35% bonds.

Now - how often should one rebalance, and how should one go about doing it

• My suggestion is to rebalance once a year or if your allocation is out of whack by greater than 5% - whichever comes first
• Rebalancing can be done with new money or old money. If you want to increase your bond allocation by 5% to bring your allocation back to a 65:35 split, add to your bond funds (buy 5% worth) with new money (salary savings etc). To use old money, sell 5% of your equity holdings and add that to your bond funds
• When rebalancing with old money, try to do the re-balancing inside of a 401k or IRA, so when you sell the equity it is not a taxable event, making your rebalance tax efficient

The act of rebalancing is an automatic way to "book profits" - now you dont need to ask - when should I take some off the table or is this a buying opportunity. If your overall stock allocation increases by more than 5% sell stock and buy bonds. If its the other way around, sell bonds and buy stock. If you allocation numbers have not changed significantly, do nothing. The selling/buying calls can be made based on your allocation numbers at any given time. Its a thing of beauty - cruise control baby!

Does diversification really help?

You must have heard the phrase - diversify, diversify, diversify. So how does one diversify?

The first step of diversification is to break your overall portfolio into

Equity (stocks)
Fixed income (cash or bonds)
and a third category that I'll call "commodities" (precious metals, energy, food products and heck even real estate).

Now within your equity allocation you diversify across countries (developed and emerging markets), across market cap (large, small companies), across value and growth and across sectors (energy, tech, Industrials)

Within your fixed income you diversify across Money market accounts, Fixed deposits, Short/Mid/Long term bonds, Govt bonds, TIPs, treasuries etc etc

Within commodities - you diversify across energy, precious metals, agriculture

OK, so lets say you did diversify your portfolio - try to put it to a real test - go back 10 years (or more) to spot a trend. You might see the following:

1) During a market downturn, your bonds/cash would have cushioned the fall
2) During a bull market - heck everything does well (maybe not bonds and cash as much)
3) Commodities are a good diversifier since they do not have a strong corelation with stocks or bonds and follow their own cycles
4) During (or due to) a downturn in the US market, international stocks (non-US) and emerging markets get hit much harder, but also bounce back much stronger

Moral of the story of-course being - don't put all your eggs in one basket - spread 'em around so they all don't all get crushed at once! Also, remember the popular saying - "There's always a bull market somewhere" - well if you are well diversified, chances are that you'll catch some of it :-)

How does one create a simple, yet fully diversified portfolio - coming up.....

Guilty? I admit I was.....

I wasn't really sure of where to begin - this being my first post and all - adrenaline rushing and thoughts of "hey I'm finally blogging". I admit I've come to the party about 10 years late, but hey I'm here :-)

Amidst all the confusion of where to begin, I thought I'd start by penning down some very common financial "sins" (if you can call them that). I can say that I have been guilty of committing a few of them not so long ago, before I checked into Vanguard's "clinic" of low cost Indexing for rehab :-)

So, to cut to the chase - are you guilty of

1) Hiring a financial "advisor" who has suckered you into "great" investments such as variable annuities, Life "insurance" policies, or high cost/load mutual funds. Yeah - those are really "great" - one small caveat - great for HIM, not for you!

2) Chasing "hot" stocks - either thru a "tip" from a friend or on bubbelvision (CNBC, Cramer)?

3) Not having an investment plan, based on your risk profile and financial goals and randomly making investments (be it stocks, mutual funds or Deposits in a bank) thinking that that'll suffice (or even make you rich)

4) Chasing high returns (yesterday's winners) and not understanding the risk - only to sell in panic when the first downturn hits?

5) Not planning your investments to be tax efficient? Remember that Uncle Sam takes away a LOT of your investment returns.

6) Not diversifying your investments - either held on to too many company stock options, invested large amounts in only a few stocks/funds that were not diversified across sectors and countries

7) Not having an emergency fund (about 8 months of living expenses) BEFORE making any other investments

8) Being "scared" of the stock market and parking too much cash in bank accounts/Deposits only to be eaten away by inflation and taxes