Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

We just had a rebalance today. For regular SAA and TAA portfolios, the next re-balance will be on Monday, July 7, 2014. You can also find the re-balance calendar for 2013 on ‘Dashboard‘ page once you log in.

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.

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

The arithmetic of investment mistakes

We have discussed in many places that investing consists of two key phases. In the very first phase, investors need to perform an extensive and systematic due diligence to choose an investment strategy that is sound and well proven. We had some more in depth discussions on this topic in the following newsletters: 

Once an investment strategy is decided, it is equally important to be disciplined enough to implement the strategy correctly.  Many of the mistakes we have observed and heard from investors and our users are implementation mistakes. They include

  • Second guessing: this is by far the most often mistake many users make. They refuse to execute a particular allocation or rebalance because of fear (markets are too high and too dangerous) or greed (I want to utilize this good period to make more money). 
  • Inertia: some people understand it is important to put their investments on track but they keep putting off. 
  • Slack off: some people just don’t have time to deal with regular rebalances, even if it is only once a month or so. 
  • Rebalance trading mistakes: can not put on and execute trades because pricing issues, brokerage restrictions etc. 

We suggest August 26, 2013: Risk Management: Implementation Risk for those who have not read it. 

Implementation mistakes can cause some serious long term damage, as can be seen in the following discussions.

A 50% loss requires 100% gain to just break even 

The asymmetric nature of loss and gain arithmetic is well published. The following table shows how the arithmetic is heavily tilted to loss percentages: 

Loss Gain needed to break even
-10% 11.1%
-20% 25.0%
-30% 42.9%
-40% 66.7%
-50% 100.0%
-60% 150.0%

One can see that as loss deepens, it requires a much higher percentage of gain to break even. For example, losing the first 10% just requires a bit more than 10% (11.1%) to break even. However, losing 50% requires 100% (i.e. double your money) to break even. When loss increases to 60%, it now requires 150% gain. So a 10% more loss from 50% to 60% requires 50% more gain to compensate (100% to 150%)!

What the above tells us is that it is critical to avoid loss, especially large loss! 

But the story does not end here. 

The double difference between loss and gain

Supposed that an investor makes a mistake in a year that results in a 10% loss (maybe due to emotional issues, subjective or speculative calls etc.). Also assume that the strategy this investor intends to follow delivers a 10% return in the same year. The difference after this year between the incorrect and correct ones is (1.1-0.9)/0.9 = 22.2%.  This difference is due to the fact that instead of losing 10%, the correct one gains 10%, so the actual amount with respect to the original amount is 1.1-09=0.2 (or 20%).

So, because of the extra gain and the extra loss on each side. the difference can be more than double. 

The following is a story told by one of our users. This user used Strategic Asset Allocation before the 2008-2009 crisis. At the low of 2008, after suffering from about 30% loss, he sold all of his holdings and since then had parked his money in cash, earning 1% or so a year till 2014. The following table shows the difference between his portfolio and the ‘correct’ one if he had stayed on course: 

  “Mistake” one Six Core TAA Moderate 
2008 -30% 1.80%
2009 1% 16.50%
2010 1% 11.70%
2011 1% 0.10%
2012 1% 8.20%
2013 1.00% 12.30%
2014 4.90% 4.90%
Difference 77176 169022

We use the tactical portfolio instead of the strategic portfolio in the above table as the user had decided to follow the tactical strategy Six Core Asset ETFs Tactical Asset Allocation Moderate (the ‘correct’ portfolio) since the beginning of the year. In the above table, assuming $100,000 was invested at the beginning of 2008. 

The difference is astounding: not only the investor has not recovered his loss, compared with the ‘correct’ portfolio, his total capital is less than half!

Permanent ‘loss’ and how wealth is made

What’s more, the above difference will remain the same forever. In fact, assuming from now on, the investor will stick to the ‘correct’ portfolio, the ‘correct’ portfolio will still be 119% more than the current portfolio. This can be proved mathematically. 

What this means is that, assuming an average 10% return after 10 years, the actual portfolio will grow to $200,173 while the ‘correct’ one will grow to $438,999. The correct one now has $238,000 more money. 

It is thus easy to see that the ‘correct’ investor is more than twice richer than this user. 

This can happen to you, your colleagues or your neighbors. Even though we might have similar financial income and wealth to begin with, a mistake in a year can result in a permanent difference or ‘loss’. 

Imagine if more mistakes are made, the difference can be even more greatly amplified. 

That is how wealth is made in a long term. The key here is to avoid mistakes! Mistakes can be extremely costly. 

Market Overview

We compare the following David Swensen’s portfolios that are listed on David Swensen Six ETF Asset Individual Investor Plan

Portfolio Performance Comparison

Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
David Swensen Six ETF Asset Individual Investor Plan Strategic Asset Allocation – Equal Weight Moderate 4.6% 7.7% 6.7% 11.0% 7.5% 0.46
David Swensen Six ETF Asset Individual Investor Plan Strategic Asset Allocation – Optimal Moderate 5.9% 10.5% 8.3% 11.5% 6.5% 0.42
David Swensen Six ETF Asset Individual Investor Plan Tactical Asset Allocation Moderate 3.5% 11.5% 10.2% 10.9% 10.0% 0.85
P David Swensen Yale Individual Investor Portfolio Annual Rebalancing 8.6% 12.6% 10.5% 14.3% 9.0% 0.53
VFINX (Vanguard 500 Index Investor) 6.5% 22.6% 16.8% 18.0% 7.8% 0.33
VBINX (Vanguard Balanced Index Inv) 4.9% 14.1% 11.3% 13.1% 7.3% 0.52

YTD: Year to Date

See the year by year detailed comparison>>

The lazy portfolio has performed very well this year because of its exposure to long term Treasury bonds and REITs. 

Market Overview

It is encouraging to see the ‘laggard’ emerging market stocks finally show some of strength. Emerging market bonds and junk bonds are also doing well. In essence, it is a risk on mode: investors seem to have no fear at the current level of valuation and market stretch. Subjectively we believe caution is warranted even though one can not see an immediate collapse. 

For new investors, to enter this elevated market requires extra caution. Again when in doubt, investing in chunks (Dollar Cost Averaging) to avoid being trapped. 

For more detailed asset trend scores, please refer to 360° Market Overview.

We would like to remind our readers that markets are more precarious now than other times in the last 5 years. It is a good time and imperative to adjust to a risk level you are comfortable with right now.  However, recognizing our deficiency to predict the markets, we will stay on course. 

We again copy our position statements (from previous newsletters): 

Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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