savings and staying course with investment strategy

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Robert T
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savings and staying course with investment strategy

Post by Robert T »

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Two points to reiterate on what's important to achieving investment goals (at least these have been for me).

1. Savings. If we don't save, we can't invest. It's that simple. this was the start of a book I read a while ago - can't recall title, but nevertheless a useful reminder. We can have the most well thought out asset allocation, but if there are no savings to invest it's not going anywhere. Start early, save consistently, curb unnecessary expenses - a small leak can sink a big ship. Great book on this ( which helped me ) is Smart and Simple Financial Strategies for Busy People by Jane Bryant Quinn.

2. Have a sound intellectual framework for making investment decisions ( what Buffet emphasizes ), and stick with it. This has helped me tremendously to navigate through the mass of options, and voices/opinions on investment choice. Stocks, bonds, value, growth, large, small, domestic, international, reits, commodities, momentum, profitability, active, passive, etfs, open ended mutual funds, indexes (there are more funds than number of stocks, and would not be surprised if there are more indexes than stocks), etc. For me - this sound intellectual framework has been the Fama-French three factor model, while not perfect, it has provided the bedrock for my investment strategy. I have had the same stock:bond, us:intl, small cap and value tilt (0.2 and 0.4 size and value load) targets for last 11.5 years. Fund choice is guided by achieving my factor load targets in least cost (most precise [alpha closest to zero]) way. My fund choices have changed, but factor load targets (the bedrock) have not. Have a framework/bedrock, whatever it may be, to anchor your investment decisions so you don't get swayed by the inevitable winds in markets/voices/opinions/product choices. This can help stay the course. Really important to have IMO.

Robert
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matjen
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Re: savings and staying course with investment strategy

Post by matjen »

^+1 Thank you Robert for this important and well-reasoned reminder.
A man is rich in proportion to the number of things he can afford to let alone.
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Blue
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Re: savings and staying course with investment strategy

Post by Blue »

Nice post.
pkcrafter
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Re: savings and staying course with investment strategy

Post by pkcrafter »

Thank you, Robert T. You've said a lot in a few words, which is a refreshing. It brings us back to simple basics. Perhaps you posted this in view of the many recent posts on factor investing. :happy

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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xystici
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Re: savings and staying course with investment strategy

Post by xystici »

I always welcome your posts. Nicely done again.
Trust yourself, Break the rules, Don't be afraid to fail, Don't listen to naysayers, Work your butt off. "It is in your moments of decision that your destiny is shaped. Choose now and well"
Almost there
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Re: savings and staying course with investment strategy

Post by Almost there »

Thank you for your perspective. Sometimes, we all need to read this again.
jimkinny
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Re: savings and staying course with investment strategy

Post by jimkinny »

Robert T
This post and your recent post re total bond market vs total stock market have been refreshing.

Thanks,

Jim
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Re: savings and staying course with investment strategy

Post by SpaceCowboy »

Robert T
Well said indeed. I keep telling my kids, it's not how much you earn, it's how much you save.
I'm curious, and I'm sure there is probably a detailed thread on it (found in your Collective Thoughts sticky and other posts), but how did you come to decide on the (1.0, 0.2, 0.4) loading point?
I'm incredibly impressed that you've had the self-discipline to stick with this for over 11 years.
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Re: savings and staying course with investment strategy

Post by Robert T »

rrppve wrote:how did you come to decide on the (1.0, 0.2, 0.4) loading point?
Perhaps the short answer is its one that works for me (so far able to stay the course).

And perhaps a longer than needed answer is the following:

Here is an extract from a post on M* site (long-time ago now). Expected returns as at start of 2003. :“Based on willingness and ability to take risk I selected a 75:25 equity:fixed income split. However based on assumptions of a 7% equity market return and 5% fixed income return this yields a 6.5% expected portfolio return (7x0.75 + 5*0.25). This falls short of the 7.6% return needed to achieve my investment objectives. Hence to achieve this higher expected return I tilted more to higher expected return factors (greater exposure to small and value companies). I assumed a future small and value premium of 2 and 4 percent respectively and targeted portfolio loadings of 0.2 and 0.4 for the small and value premiums. The expected returns of the equity portion then becomes:

Market beta x market return........1.00 x 7.0 = 7.00
Value loadings x value premium....0.40 x 4.0 = 1.60
Size loading x size premium.........0.20 x 2.0 = 0.40
Expected equity return..............................9.00

So my portfolio expected return is now (9x0.75 + 5*0.25) = 8 minus expected expenses of 0.35% leaves 7.65% (8.00-0.35) which is close to my needed expected return. The reasons for using double the loading for value over size is that the value premium appears to have been historically more robust than the size premium and has a lower correlation with the market. Perhaps this is a little too simplistic but that is how I did it.”

The expected equity market returns were from Bill Bernstein’s 2002 edition of Four Pillars – which if I recall, and adding an ‘expected’ 3% inflation rate, were ‘expected’ long-term returns of 6.5% for US markets, 7% for EAFE markets, and 9% for EM (assumes 3% inflation) – which when combined in my 50:37:13 US:EAFE:EM allocation comes to 7%.

Why not just 100% market equities? Diversification

Following the above, one third in each US:EAFE:EM stocks could have led to the similar after expenses expected long-term return as I need. The reason I didn’t use this approach is diversification. Here is an earlier Asness paper on this point http://swyxcapital.files.wordpress.com/ ... uities.pdf Asness argues that a (explicitly) leveraged 60/40 portfolio provides a more ‘optimal portfolio’ that a 100% stock portfolio. However, as Swensen (in his 2000 book on Pioneering Portfolio Management) indicates there can be both explicit and implicit leverage.
  • “Simply holding riskier-than-market equity securities leverages the portfolio…the portfolio either becomes leveraged from holding riskier assets or deleveraged from holding less risky assets. For example, the common practice of holding cash in portfolios of common stocks causes the domestic equity portfolio to be less risky than the market, effectively deleveraging returns.”
I think Aness’s example of adding small caps in the earlier linked paper is an implicit form of leverage, as I do in my equity holdings with a small cap and value tilt. However I ‘deleverage’ my small cap and value tilt with the addition of 25% bonds. I think the end result is my portfolio provides a more diversified portfolio than a 100% stock portfolio.

Interestingly from 2003-2013 a portfolio with one third in each US:EAFE:EM stocks had 11.8% annualized returns with a 2008 return of -44%, while my portfolio had 11% annualized with a 2008 return of -29%. Obviously no guarantees going forward, and there can be long periods of small and value stock underperformance, which would give significantly different results to the actual over the last 11 years, but over long-term I think small cap and value stock will have higher returns (from higher risk), and that adding bonds provides added diversification (and downside protection).

Not for everyone, but works for me. Ovbiously no guarantees. Time will tell.

Robert

PS. Asness makes similar point on 100% equities in this more recent paper on "Rubble Logic: What Did We Learn from the Great Stock Market Bubble?
http://www.cfapubs.org/doi/pdf/10.2469/faj.v61.n6.2770
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