May 21, 2012: Equity Investments

05/22/2012 Share 0 comments

Re-balance Cycle Reminder

Based on our monthly re-balance calendar, the next re-balance time will be on next Monday, May 28, 2012. You can also find the re-balance calendar of 2012 on 'My Portfolios' page.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Also please note that we now list the next re-balance date on every portfolio page.

Equity Investments

We continue our coverage on the four corner concept for building an all weather portfolio. See our pervious newsletters so far on this topic:

• April 23, 2012: All Weather Portfolio Construction, 
• April 30, 2012: Inflation Hedges,
• May 7, 2012: Bonds As Deflation Hedges
• May 14, 2012: Cash Is The King

In this article, we will discuss the equity investment corner.

Equity (stock) investments are perhaps the oldest, most exciting and most popular investments around. In fact, when people talk about investing, most would equal it to stocks. People are bombarded with stock investing daily news and reports (CNBC please!).

However, for a balanced and serious investor who is investing his/her wellbeing, stocks should be treated just as one type of investments, nothing more and nothing less.

From a top down approach, we can break equity investments into the following categories:

Global/Geographical:

• U.S. stocks
• Developed country (non-US) stocks including European and Japanese stocks.
• Emerging market stocks including BRIC (Brazil, Russia, India and China)
• Frontier market stocks including countries like Thailand, Africa etc. 

Strictly speaking, the last two categories are not geographical. Another way is to use funds or ETFs such as Asia Pacific, Latin America etc.

For an average investor's portfolio, spreading equity investments among U.S. stocks, Developed Country Stocks and Emerging market stocks is good enough to diversify and capture growth opportunities. Our simplest Six Core Asset ETFs  represents such a simpler is better concept.

A more aggressive way is to use individual country stock funds or ETFs. However, this adds more complexity in managing these investments. For most country stocks, they are a lot more volatile than the U.S. stocks. So if you adopt this approach, you need to make sure enough countries are covered for diversification purpose.

Stock styles and sectors

Within each segment (such as US stocks or developed country stocks), one can further divide stocks into so called 'Morningstar style box' as follows:

This essentially represents two important stock investing factors: size and value. Research has shown that these two factors play important roles in deciding a stock investment portfolio's returns.

MyPlanIQ Diversified Core Allocation ETF Plan  has these 9 style stock ETFs that can be rotated through to enhance returns based on their total return momentum. Research and empirical data have consistently shown that style rotation can improve returns up to 1-2% in a long period.

A more aggressive stock investing is through stock industry sectors. For example, U.S. stocks can be divided into the following 10 sectors:

All of the above asset classes are shown on 360° Market Overview.

In general, sector investing is more volatile than style investing.

Dividend Stocks

As more and more investors realize that the coming decade is going to be a low growth environment, dividend stocks are attracting more and more attention. We believe this is a healthy trend.

As some long time readers might notice, we are a firm believer in dividend investing. Dividends represent immediate payoff to shareholders. Though some company executives (such as Berkshire Hathaway's Warren Buffett) can smartly allocate capital and increase shareholders' value more by reinvesting earnings, majority of executives do not allocate capital prudently and often squander earnings in some ill conceived short term projects or resources (remember many executives are career makers so their wellbeings are not necessarily aligned with shareholders). Distributing part or majority of earnings to shareholders force company managements to be lean and mean and operate more conservatively. Real Estate Investments Trusts (REITs) are the extreme example in earnings distribution: by law, 80% of earnings in an REIT is required to be distributed to its shareholders.

Retirement Income ETFs or Permanent Income Portfolio are the examples of using dividend stock ETFs as main stock investing vehicles.

Individual Stocks or Index Funds

For average investors, we do not advocate individual stock investing approach. We further believe to achieve reasonable returns, low cost index funds are ideal instruments (and good enough for that purpose).

However, we do recognize that there are still advantages to invest in some individual companies that are solid and well run (and with reasonable cheap prices), especially for experienced investors. Furthermore, it is possible to rotate through actively managed funds to achieve better returns. But these topics are beyond the scope of this newsletter.

Portfolio Reviews

Last week, we compared tactical lazy portfolios lazy portfolio tactical model portfolio performance comparison. This week, we take a look at the strategic allocation lazy portfolios.

See lazy portfolio strategic model portfolio performance comparison for more details.

Overall, these portfolios have done well year to date. In fact, they have done well for the past 3 years.

Market Overview

By last Friday, stock markets had gone full force correction. In fact, In our major trend ranking table, the last one standing ever strong REITs was knocked down all the way to be in about the same position as that of the total bond index (BND).  However, Monday (today's) recovery made REITs back to the top 3 rankings again. Other than REITs, all the major risky assets including U.S. stocks (VTI) are now ranked below the total bond index.

The central banks' QEs/LTROs or whatever stimulus measures have provided a floor to global equity markets (the Bernanke's put, for example). This phenomenon may or may not be able to continue. Markets are showing similar behavior as last year but again, there is no guarantee it will be a repeat. We will stay on the course.

For users who are uncomfortable with their risk level, we again urge them to review their portfolios' risk levels. It is not too late to pare down excessive risk (if there is any) at the moment.

See MyPlanIQ 360 Degree Market View for more details.

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