Rebalance Your Portfolio

Welcome to Spring Cleaning Week! This is the first post of the week and something I think too many people overlook – rebalancing your investment portfolio.

Rebalancing your portfolio is important because the key to investing is establishing a plan and following it. You can’t predict the bubbles before they happen in the hopes you can buy on the upswing. You can’t predict the sharp drops in the hopes you can sell before they hit. What you can do is establish a reasonable plan, adjust it as needed, and follow it to prosperity. With that in mind, the goal of rebalancing is to get your investment reality back in line with your plan.

This post is part of the 2011 Spring Cleaning Week!

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 Personal Finance 

A Money Rebuilding Year

Construction WorkerIn every professional sport, there’s a concept of a “rebuilding year.” These are the years where the team is working on drafting good prospects, building up their young talent, and crafting a competitive championship-caliber team piece by piece. It’s difficult to field a championship team every year for more than a few years, with free agency and everything, so it’s expected that after a few years of stellar performance, you’re bound to have a few leaner years where you’re rebuilding your talent. The good teams do this well, with strong performing rebuilding years, and others do it poorly.

How does this apply to you? It’s a little downside psychology. With the recent economic crisis, a lot of folks are forced into their rebuilding years. You may have lost your job. Your investments may have lost value. Your money doesn’t seem to get you as far as it used to… you’re down, but not out. So turn this year into a money rebuilding year.

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How To Invest Like Harvard & Yale

I’ve had asset allocation on the brain lately (it’s hard not to with all this volatility), it doesn’t hurt that the stock market has seen some tectonic shifts these last few weeks, and so I turned to an article published earlier this year looking at the asset allocations of college endowments. Specifically, this article looked at Harvard’s exceptional 15% return per annum over the last ten years and Yale’s mind-blowing 17.2% return over that same time period. While I’d be curious to know how they’re doing nowadays, the fact remains that their returns are still laudable and worth investigating.

Harvard & Yale Asset Allocations

Harvard & Yales Investment Allocations

The chart above was pulled from the article and it shows a very simplified view of a very sophisticated portfolio. The first thing that probably jumps out at you is the fact that, in both portfolios, there’s only a mere 12% held in domestic equities – that’s the stock market. Chances are you have more than 12% in equities.

Another significant factoid from that chart is that the largest holding they have is in real assets such as real estate and commodities. Again, chances are you don’t have much invested in real assets (unless you count your house, which is less an investment decision as it was a living decision).

Finally, both have a huge piece in private equity (like hedge funds) and absolute return (assets that are supposed to yield a return in good and bad markets).

How Can You Do This?

Smart Moneys Ivy League Replica Investment Allocations

This one is again from Smart Money and it shows how you can replicate the holdings (or at least get as close as possible) of Harvard and Yale through various funds. Want some absolute growth? PIck up some Hussman Strategic Growth (HSGFX). Want a taste of private equity? PowerShares Private Equity ETF (PSP) will get you into that game.

Worth a shot right? Or go with something simpler like a lazy portfolio. 🙂

A League of Their Own [Smart Money]


Consider Your Job In Asset Allocation

Gold BarsHere’s an idea I spotted in the lasted issue of Money Magazine:

Consider your job as an asset in investment asset allocation decisions.

The gist of the article was that when you’re young, your greatest asset is your human capital. That is, your ability to take your time and turn it into money (salary, commissions, etc.) is your greatest asset. As you get older and accumulate other assets, your financial assets will begin taking up a larger and larger piece of your portfolio. It’s the old adage of making your money work for you. As this happens, remember to treat your job and your income as an asset when you make decisions about your asset allocation.

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 Personal Finance 

Mortgage Heatmaps, Roth 401(k)s & Repetition

I discovered this detailed real estate blog called Matrix and this incredible set of mortgage-related heatmaps used by Bernanke in his last speech. Heatmaps are the quickest way to get a “snapshot” of a situation and these go through so many permutations that you can get a really good sense of what’s going on (and there are so many maps!). I had no idea unemployment concentrations were dispersed the way they are and how badly hit the Michigan area has been lately given the major auto manufacturer’s financial woes.

My last employer recently offered a Roth 401(k), which is essentially a tax-free version of the tax-deferred 401(k), though employer contributions are tax-deferred. It’s an interesting concept that has been around for a few years but hasn’t been adopted too widely, probably because of the paperwork. If I had a choice, I’d split my contributions evenly between the two and give myself some diversification.

Trent has received numerous complaints that he writes about the same stuff over and over again and that it’s getting old. Unfortunately for all you excitement hounds, personal finance is repetitive, it is conceptually easy, and “slow and steady” does win the race. It’s the chase of excitement, having that fancy car so you can drive it fast, throwing some money at a high flying potential stock, or that huge flat panel television -I that’s the stuff that derails your trek to your personal finance goal. Spend less than you earn, contribute to your 401(k) and save for retirement, ensure you have proper and adequate insurance, blah blah blah – it’s repetitive but it works. Michael Jordan once said he shot a thousand free throws a day. How’s that for repetitive?

Nickel wrote a bit about his asset allocation this week and it’s something I am hoping to review sometime next week. I’ve input all the data I have into Vanguard’s Portfolio Watch and now I just have to figure out what my goals are so I can set things up correctly once and for all.

Housing doesn’t always go up. Sometimes it comes down. Hard. (scroll down to the story of the house that sold for $505k in 2006 and is now on the market for $177,495 – ouch)

Lastly, if you like heatmaps and those first dozen weren’t enough, here’s a cool one about all the pieces of inflation on the New York Times, my new BFF, courtesy of Consumerist (who got it from Nathan). Not surprisingly, that big red area is gas.

Have a great weekend!


Why I Don’t Invest In Peer-To-Peer Lending

In the blogosphere there seems to be a lot of excitement about peer-to-peer lending which is the ability to lend money to other individuals through companies such as Prosper and Lending Club. While I can understand how some investors will always be interested in a new investment product I don’t really understand the widespread excitement and interest level for this one.

Some of the things people should think about when considering P2P lending:


Lending to one person is kind of like investing in a very small risky stock such as a junior mining company or a startup biotech company. You really don’t know much about that borrower and if something happens to them such as a medical emergency then your loan to them might be at risk. You can mitigate this risk by lending using a portfolio plan but I suggest that while this does reduce your risk, it doesn’t change the basic asset class which is still quite risky. A portfolio of p2p loans is like a mutual fund with numerous junior mining companies). You reduce the risk of any one company failing but aren’t protected against events that affect all junior mining companies ie falling metal prices.

One of the big risks that I would be concerned about is if interest rates go up. Presumably people who borrow on p2p are people who can’t get the loan from a bank at a normal rate – I would assume these people have already maxed out their credit or at a minimum have a lot of debt which makes them very vulnerable if interest rates increase.

Same as the old bank

Brip Blap wrote an interesting post on P2P which indicates that the lender “is the bank”. I have to disagree with this because I think Prosper or Lending Club is the bank. The only thing that really changes is that the p2p lender gets to choose who the borrower is which is not the case when you give money to a regular bank to get interest. Another issue I have is that Prosper and CL seem to be spending a lot of money to get clients – advertising, free money giveaways. Where does this money come from? As far as cutting out the middle man – P2P institutions charge for the loans so I don’t really see how they are very much different from banks.


Another concern I have is that I think the interest rates are too good to be true. If a borrower is willing to take my money for 10% then I know that they couldn’t get that same loan at a bank. This is problematic for two reasons –

1. The banks are far better at analyzing debtor risk than you or I (too bad they couldn’t analyze subprime securitization loans) so if they don’t feel the person is worth the risk at 10% then you are not getting a deal – you are getting a high risk loan.
2. If the person seems to have reasonable credit then they might have maxed out all their available credit which implies to me that their credit score is meaningless in that situation.

The fact that p2p has not been around very long also means that any default rates are probably understated. A loan can go into default at any time in the three year term so looking at default rates before three years is not going to be very accurate. Also – with the default rates do they do it by time periods? ie years? if not then any new loans will decrease the default rate dramatically.


In the US, interest income is treated as regular income for taxation purposes. Dividends and capital gains are given preferential treatment and you will pay less than than on interest. You will be better off taxation wise to have all three of those investment types in a tax-sheltered account such as a 401(k) or ROTH account. If however you have investments in a taxable account then ideally it should not be fixed income such as bonds or P2P loans. Since P2P loans are not eligible for tax sheltered accounts then the extra taxes will reduce returns significantly.

Asset allocation

Asset allocation or the type of assets you invest in (ie stocks, bonds, cash) is a critical step in the investment process. Personally I have 25% of my investments in fixed income and 75% in equities (stocks). Regardless of the expected rate of return, P2P lending is considered fixed income and it should fit into your desired asset allocation.

Basic economics

If something is too good to be true then it probably isn’t. Currently you can get approximately 4% interest on guaranteed certificates or accounts. If you invest in P2P loans and have an expected return of 10% then that puts you in a much higher risk level and there is a reasonable chance that you could lose 10% or more (much like equities).

Bottom line

I have no plans to invest in p2p loans anytime soon because they don’t fit my investment plan. I do want to make it clear that I’m not suggesting that p2p loans should be avoided or that they are a bad thing. If you know what you are investing in and it fits your investment objectives then go ahead and lend away!

This post comes from Mike of Quest for Four Pillars, “another Canadian Financial Blog,” that traces its namesake to none other than the Four Pillars of Investing by William Bernstein.


Know Your Investing & Market History

I was reading an article the other day (I about the importance of paying attention to your asset allocation mix, rebalancing, the usual exciting investment stuff, when I stumbled upon this passage (third paragraph):

Not to scare you, but that’s a risky situation. If one of your largest asset classes should take a sudden fall – the way emerging markets plunged nearly 60 percent between 1997 and 1998 – your returns will go into a tailspin along with it. [link]

The “not to scare you” part is in reference to advice that you shouldn’t let an asset type, in this case emerging markets, get too large without rebalancing to reduce, or at least spread out, your investment risk.

While that in and of itself is sound financial advice, the most significant idea I got out of reading that article was that I don’t know much about the history of the markets. My investing history is exceptionally weak. By investing history, I mean all the swings, bubbles, bursts, run-ups, corrections, crashes, etc. in the stock market, bond market, housing market, and other various markets and as a result, I’m doomed to follow the “sky is falling” mentality of mainstream media. My investing history is limited to the big ones like Black Monday back in 1987 and the trivia ones like the tulip bulb craze in the 17th century, but I had no idea emerging markets crashed 60% between 97-98. Did you know that the peak of the dot com boom to the trough of the burst lasted 929 days?

Do yourself a favor and check out this great resource by Fortune in which you can view the performance of the markets over the last 50 years? Spanning the top are the Presidents and Fed Chairmen and the chart reflects the performance of the markets along with periods of bear markets and recessions. It’s a superficial look but it’s a jumping off point.

If you see any periods that look especially interesting, such as the 20% drop that started in the summer of 1990 and ended in the fall, start doing research to see what caused it, how people reacted, etc. What’s especially interesting is now you can read the archives of many popular newspapers such as the New York Times, you can read the sentiment of the writers and the public by scanning the archives. Panic and irrational reactions aren’t 21st century creations, they existed back then too (much like irrational exuberance!).

 Monthly Review 

Financial Outlook – Summary of Spending and 401k Allocation (Jan & Feb ’05)

A lot of personal finance blogs reveal their author’s entire financial picture; so that you can follow them on their quest and help them achieve their goals. I’m not going to give that much information but I think that in order to help me improve my budgeting system, I have to reveal it to the world and have the world poke holes. We’ll track it back to the start of the year. I’ll also give you a look into my 401k as well, percentages of course. In future posts in this category, Financial Outlook, it won’t be quite as verbose as this one.

Expenses Jan. Feb. Target %
Rent 18.66% 18.66% 20%
Utilities 3.87% 5.12% 5%
Meals 4.10% 10.25% 7%
Groceries 2.50% 7.54% 7%
Clothes 0.35% 1.47% 0.5%
Cleaning 0.42% 0.00% 0.5%
Automotive 30.01% 0.00% 2%
Transportation/Gas 5.90% 7.23% 7%
Recreation 4.79% 13.44% 10%
Other 12.84% 0.00% 3%
Savings 16.56% 36.28% 25%
Budget Reserve** 13%

* These percentages are calculated against my post-tax income, which already has 20% contributed to my employer’s 401k plan.
** Budget Reserve is simply my safety blanket in the budget for overruns. 13% seems like quite a bit but any excess falls into Savings!

Budget Notes:
Automotive (Jan): Last December, I was in an unfortunate car accident that totaled my car (2000 Acura Integra) at no fault of my own. So I had to purchase a new (used) car, which was a 2003 Toyota Celica, from a private owner in Florida with the insurance company’s funds. But, that also meant I needed to purchase four new all-season tires (since Florida cars don’t know of seasons) which set me back in the Automotive category. Usually that category is very small, consisting of oil changes. I also had to get the tint removed to pass inspection, a $100 ding.
Other (Jan): Usually the Other category is also pretty small too, I try to put anything I spend in a category other than Other. I made a donation to the American Cancer Society and I couldn’t really justify putting it anywhere so it went into Other.
Meals (Feb): 10% is far too much to be spending on Meals. I usually try to keep this somewhere under 7% (achieved in January) and I’ll have to bring lunch to work more often.
Recreation (Feb): I took a nearly weeklong trip for Mardis Gras and a weekend trip to Seven Springs ski resort. I’m allowed to take vacations! 🙂

I don’t really restrict my spending to a dollar amount but I do try to keep things in range of percentages I feel comfortable with. I want to save at least 20% of my income, 30% if possible, and I trim where I find it easiest to trim. Sometimes aberrations (like Automotive in January) are unavoidable, that’s when the Budget Reserve comes into play. Hopefully overruns don’t exceed 13% and starts to dip into the real reserve, my emergency fund.

Onto the 401k…

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