Sectors and Asset Classes

Follow-up information for 2013 AAII presentation “Dynamic Portfolio Construction in the Context of Comprehensive Wealth Management.”

Here are some large cap stocks with very low 12 month trailing P/E ratios.

Q: I am looking for a way to get into the distressed real estate market. What recommendations do you have about investing IRA or 401(k) funds in rental houses?

With the enormous increase in the taxation of dividends, high net worth investors may be tempted to abandon dividend-paying stocks entirely. This is not necessary.

As you get closer to the hole with each shot (this could be too much of an assumption for those hack like me) you can focus on precision over power.

Four reasons not to abandon a brilliant allocation that includes emerging markets simply because of short term fluctuations.

MarketWatch is seeking a top-notch writer who will bring a fresh perspective on money to the world’s investors. We believe that fresh perspective ought to include the idea of freedom investing.

Sometimes the medium term trend seems to weigh more heavily in our minds than the long or short term trends.

“Anyone who’s bought gas, paid a medical bill or sent a child off to college recently knows that the Consumer Price Index doesn’t tell the whole story of inflation.”

“Real estate investment trusts should be much more than an optional selection in a balanced investment portfolio.”

“A growing link between municipal bond and U.S. stock performance could be very bad if equities fail to rise robustly over the next few years.”

Direct ownership of gold has become more popular, despite some lingering fear that the government could again ban private gold ownership. With ongoing concerns about the global financial system and gold hitting a record high, many people are interested in this “safe haven.”

Sector rotation would suggest that we are still at the beginning of a market recovery. This is probably the bottom of energy stocks.

“Investors may hold fixed income securities to reduce portfolio volatility, generate income, maintain liquidity, pursue higher returns, or meet a future funding obligation.”

Emerging market bonds are an attractive way to get a higher yield, but historically they have come with higher volatility and a high incidence of default. But that has been changing.

I was on the radio today and someone called in claiming that Vanguard Emerging Market ETF (VWO) had done nothing but go down in value.

A large number of people in the United States are worried about our profligate spending and the resulting devaluation of our currency. They are worried about politics and socialism and the economy.

Precious metals will, on average, just keep up with inflation, but your after tax return would mean you fell behind inflation by the 28% tax you must pay.

When growth is relatively cheap it should outperform value.

The Marotta allocation method is a proportionally weighted allocation based on the square of each Sharpe ratio. Squaring the Sharpe ratio drastically reduces asset categories in proportion to their distance from the efficient frontier.

Q: Do you recommend dividend-paying stocks? If not, what investment strategy do you recommend for retirees like me who are seeking income from our portfolios?

Diversifying your portfolio means finding assets that have value on their own merits but do not move exactly alike. Here are the principles on building and rebalancing asset classes and subcategories.

Crafting portfolio asset allocations is a combination of art and engineering. Just as a blending of colors can produce cerulean, so a blending of indexes produces a unique shade of risk and return.

Even if the overall inflation rate is only 2.25% in the next 10 years, an investor who holds a 10-year Treasury until maturity will realize a zero real return after inflation.

A stock’s valuation is measured on a continuum from “value” to “growth” In broad strokes, value stocks are cheap and growth stocks are expensive.

The second factor of investing is size as measured by a stock’s total capitalization. Over time small cap will outperform large cap even after factoring out measurements of volatility.

Most investors do not have a balanced portfolio. And by chasing investment returns they miss the easy money they could make from having a good asset allocation in the first place and rebalancing it periodically.

In the midst of this turmoil, especially after this past summer’s sharp drop, many investors wonder if they should put all of their investments into something safe and avoid the markets altogether.

Although the house does not pay me any money on an ongoing basis, I think it will represent a very good return on my money invested should I decide to sell.

Q: Is it now time to short Treasuries? What do you think about using inverse ETFs to play the inevitable bear market for U.S. bonds?

I’m in my 20s and I’m just getting started in the working world. Which of the attached 401(k) investment choices do you recommend?

What advice do you have for someone who is considering a strategy shift toward fixed income?

Q: I am receiving some extra cash as a result of maturing CDs. I want to make a safe investment that is protected against future inflation. We do not need this money, and so I am interested to know what you think of purchasing I bonds for our grandchildren. I have heard they can be tax free if used for college.

“Structured products’ risk-reward ratio is worse than you think.”

Adding bonds to an all-stock portfolio can boost returns and lower volatility, especially in choppy markets. Bonds should be a small but important part of your gone-fishing portfolio allocation.

International bonds now make up more than 35% of the world’s investable assets, and yet many domestic investors have little or no exposure to these securities.

Hard assets have been one of the most significant asset classes over the last decade. From all indications, it will continue to be a critically important investment category to protect your portfolio from the effects of inflation and the continuing devaluation of the U.S. dollar.

David Marotta discusses why real estate should be part of a portfolio asset allocation.

Even in our gone-fishing portfolios we suggest investing more overseas than in the United States. For most investors, foreign stocks will be their largest and most important allocation. Including the right mix of foreign stocks will help you relax and go fishing no matter which foreign seas are in turmoil.

Creating a gone-fishing portfolio begins with a top-level asset allocation. We use six asset categories. The three for stability are short money (maturing in less than two years), U.S. bonds and foreign bonds. The three asset categories we use for appreciation are U.S. stocks, foreign stocks and hard asset stocks.

In 2010 I published a column entitled “Now’s Still the Time to Buy a House.” Investing is like chess in slow motion. It is important to review your moves to see how they turned out. Sometimes they don’t turn out well. Our prediction about real estate, however, was brilliant.

Finding countries where you can plant your investments in fertile soil may be one of the most important asset allocation decisions you make for the next several years.

Perhaps dire predictions are correct and we are headed to Armageddon. If you want liquid assets in such a catastrophic situation, try buying cases of Jack Daniels. It is cheaper, keeps just as well and will fetch more in trading value.

A few months ago Bill Gross, co-founder of PIMCO and the country’s most prominent bond expert, singled out those countries heaping significant deficits on their mountain of debt and called them “The Ring of Fire.” We recommend that you reduce your investments in these countries.

Real estate could be a great investment right now.

Everyone is expecting real estate to underperform the stock market for many years going forward.

Rebalancing between asset classes boosts returns and decreases volatility. But setting your asset classes based on sectors of the economy is not an effective strategy.

Diversifying your portfolio means finding assets that have value on their own merits but do not move exactly alike. A critical investment metric called “correlation” is used to construct a portfolio most likely to meet your personal financial goals.

Gold may glitter, but it is still better to own the mine.

Just over two years ago, we warned our readers that real estate prices might be peaking and ready to correct.