03/24/2011

Life moves quickly. Already this year we have seen troubles in Egypt being supplanted by Tunisia and Bahrain. This was swept into the background by the triple disasters in Japan and now Libya grabs the headlines. All of this twists and turns markets all the while, we may worry about how that impacts our retirement as well as being caught up in the human tragedy.

One of the most glaring holes in our education system is retirement investing. As a result, we feel afraid and powerless and look to “big brother” to help out. Be aware that some of the biggest pension schemes in the country are failing with terrible returns. Many states are in real trouble because of the pension liabilities so they aren’t doing any better. As inflation bites, it is unlikely that these pension schemes will keep up. In any case, increasingly they are a thing of the past. 401K plans have moved from being an adjunct to a pension plan to being the mainstay of retirement income. In a study of over 800 mainly retirement plans, we noted that the majority of plans supported only three asset classes which is going to have a significant impact on the potential returns for the participant.

Sadly, only 4% of the plans we reviewed had the six asset classes to build the sort of portfolios necessary to optimize returns and minimize risk.

In a previous article we found reviewed historical simulations from a five asset class plan would, over a decade, put 75% more money in your pocket compared to a three asset plan which is the staple of most 401(K) plans. In this article, we are going to add commodities as another class to provide diversification protection.

We use a simple benchmark vehicle -- SIB -- simpler is better to show the potential difference in returns between the portfolios with different numbers of asset classes.

Each of the SIBs are built from one ETF per asset class. The ETFs we selected for these portfolios are as follows:

So the three asset SIB has (VTI), (VEU) and (BND). The four asset SIB adds emerging markets (VWO). The five asset SIB adds Real Estate (VNQ). The six asset SIB adds commodities (DBC). Note that these ETFs were chosen arbitrarily. If you want to see a range of alternatives and their relative performance, MyPlanIQ maintains updated information on major ETFs in most asset classes.

Commodities can be volatile and some may have trepidation in owning this type of asset. ETF's which are broadly diversified reduce the volatility and don't rely on fund managers who can be hit or miss. In the coming years, commodities will be important and have already shown their value as inflation is an issue in emerging markets and will shortly start to arise more locally.

If we compare the historical returns between the five and six asset SIBs, we can see the benefit of adding the extra asset class.

Performance chart (as of Mar 2, 2011)

Performance table (as of Mar 2, 2011)

If we ignore the short term difference -- which are not insignificant -- and look at the five year returns we see a difference between five and six assets.. Note that the difference in returns between three and six asset SIB, over a decade -- puts more than twice the amount of money in your nestegg.

We also note that after starting the year very strongly, US Equities gave back much of their gains over the past month -- something that a portfolio with access to commodities and real estate mitigated to a large degree.

You may not have all the asset classes in your current 401K plan -- but if you have an IRA or the chance to rollover an old 401K into an IRA and assemble a six asset portfolio, you will thank yourself when you retire.

Disclosure: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Exchange Symbols:(NYSE,VTI),(NYSE, ,SPY),(NYSE,VEU),(NYSE,EFA),(NYSE,VWO),(NYSE,EEM),(NYSE,VMQ),(NYSE,IYR),(NYSE,BND),(NYSE,AGG),(NYSE,IEI),(NYSE,SHY),(NYSE,TIP),(NYSE,EFV),(NYSE,IWM),(NYSE,IWN),(NYSE,IWW),

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03/22/2011

Retirement investing is a long term proposition and is similar to looking after your health – do what is sensible and have occasional checkups that become more frequent as you age. One of the most glaring holes in our education system is retirement investing. As a result, we feel afraid and powerless and look to “big brother” to help out. Be aware that some of the biggest pension schemes in the country are failing with terrible returns . Many states are in real trouble because of the pension liabilities so they aren’t doing any better. As inflation bites, it is unlikely that these pension schemes will keep up. In any case, increasingly they are a thing of the past.

A simple portfolio (six ETFs – index funds – no fancy management – one fund for each of six different classes). over a five year period, buy and hold has returned 7% and a more active momentum strategy has returned 13%. This is a simple, easy to understand fund and investment approach that can be used as a benchmark for what others are telling you.

We are investigating and breaking down luminary portfolios for ideas and approaches to retirement investing to help gain understanding and experience.

The FundAdvice Ultimate Buy and Hold Portfolio is tracked by MarketWatch.com's lazy portfolios, maintained by Paul Farrel. The portfolio is very diversified in equity asset classes although corporate bonds are missing. The plan consists of 11 funds. These funds enable participants to gain exposure to 5 major assets: US Equity, Foreign Equity, REITs, Emerging Market Equity, Fixed Income.

As of Mar 21, 2011, this plan investment choice is rated as average based on MyPlanIQ Plan Rating methodology that was designed to measure how effective a plan's available investment funds are . It has the following detailed ratings:

Diversification -- Rated as average (49%)
Fund Quality -- Rated as average (48%)
Portfolio Building -- Rated as above average (72%)
Overall Rating: average (58%)

Portfolio Discussions

This is a well balanced portfolio with access to five asset classes. In the original, Emerging markets and Real Estate is underweighted and Commodities are not represented at all. We are going to compare the original portfolio with an ETF portfolio with standard Strategic Asset allocation and Tactical Asset allocation weightings.

The ETF Portfolio has:

(EEM) for emerging markets, (SPY) forlarge blend, (IEI) for the intermediate government bond, (SHY) for the short treasury, (TIP) for inflation protected bonds, (EFV) for foreign large blend, (IWM) for the small blend, (IWN) as small value, (IWW) for large value, (IYR) for real estate


SAA will have 40% in Fixed income and 15% in each of the other asset classes
TAA will have 40% in Fixed income and 30% in the two top performing asset classes

The ETF portfolio uses a simpler structure -- one ETF for each asset class -- VTI or SPY, VEU or EFA, VWO or EEM, VMQ or IYR, BND or AGG.

With any of these ETFs, we would expect the performance would be similar to the Mutual Fund versions because they have high trading volume. They don't have the same history as the Mutual Funds if you want to go back ten years.

Performance table (as of Mar 21, 2011)

What we can see is that the buy and hold strategies -- the original portfolio and the two strategic asset allocation portfolios -- were running neck and neck with the tactical portfolios until we started to hit significant market turbulence around 2007. Until the spring of 2009 the tactical portfolios were clearly ahead but as we came out of the recession, it's possible to see that the buy and hold strategies have closed the gap somewhat. This is a great way of understanding what the two approaches bring over the long term.

We note that the buy and hold strategies are virtually indistinguishable. The original portfolio has been well chosen in the sense that it is only rebalanced once a year and there is no rotation of sub-classes (for example between the different fixed income or US equity classes) and it has barely suffered at all. In a future article we will drill into the last few months and see whether moving some or all of the fixed income into cash has helped the two SAA portfolios squeeze out a little more of late.

We also not the difference between the two TAA portfolios. The Five asset benchmark with only one fund per asset class has outperformed the plan with multiple choices. Research has shown that rotating assets in subclasses can bring benefits but, in recent days, that hasn't proven to be the case with the exception of moving fixed income to cash. The simple benchmark plans have done remarkably well over the past five years.

The key takeaways are:

• Over the longer term, when there have been downturns in the market, a tactical asset allocation strategy wins out
• When the markets are doing well, buy and hold wins out
• Be careful about asset class rotation -- it doesn't always give you the best returns
• You have to be involved and aware to get the most out of your investments

We can expect choppy markets over the next few months and care should be taken as to which strategy is selected.

Disclosure:

MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Exchange Symbols:(NYSE,VTI),(NYSE, ,SPY),(NYSE,VEU),(NYSE,EFA),(NYSE,VWO),(NYSE,EEM),(NYSE,VMQ),(NYSE,IYR),(NYSE,BND),(NYSE,AGG),(NYSE,IEI),(NYSE,SHY),(NYSE,TIP),(NYSE,EFV),(NYSE,IWM),(NYSE,IWN),(NYSE,IWW),

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03/20/2011

Investing for wealth preservation and growth or for retirement purpose is by definition a long term process. In a long term period, experiencing wars, natural disasters and political or social unrests is a fact of life. How to deal with and navigate through these threatening events is pertinent to the success to achieve financial goals. 

As baby boomers are exiting or getting ready to exit the work force, this year suddenly saw many dramatic events unfolding: Japan's earthquake and the still unfolding nuclear power meltdown events, the middle east violence with fear of radical islamic involvement and, this weekend's airstrike by allied forces on the Libyan regime are all pointing to certain tipping points in the world economic and political landscape. The new generations and the baby boomers suddenly find themselves in a world with entangled dangerous events. 

The events certainly made their marks on financial markets: the big swings of the Dow Jones Industrial stocks (DJI) and S&P 500 stocks (SPY) left a dent on the otherwise stubborn euphoric markets. Most risk assets including U.S. stocks (SPY) (VTI), international stocks (EFA) (VEU), emerging market stocks (EEM) (VWO) and REITs (IYR) (VNQ) (RWX) lost ground in the last week. The only standout in the group is commodities (DBC) (GSG). For the week, DBC actually gained 0.78% while gold (GLD) gained 0.11%. For more detailed performance information, please refer to here.