"The Intelligent Portfolio" -- A Gem

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"The Intelligent Portfolio" -- A Gem

Postby Taylor Larimore » Mon May 05, 2008 11:10 pm

Author Christopher Jones is CFO of Financial Engines founded by Nobel Laureate, Wm. Sharpe using Monte Carlo simulations. This book is not for beginners and promotes Financial Engines. But the book is beautifully written with numerious charts and tables. It is a full of investment gems like these:

"Through modern media and advertising, we face a veritable blizzard of useless information vying for our attention."

"Investors should start with a view of skepticism." (Arthur Levitt quote)

"Putting it mildly, there is a lot of dumb advice out there when it comes to investing."

"Things you hear about the most (such as past performance) are often among the least important factors in making good investment decisions."

"Sadly, our educational system has been woefully behind the curve in preparing people for the heavy new financial responsibilities of a self-directed investment world."

"A big part of being an informed consumer of investment advice is being able to detect when your advisor may be making claims that don't stand up to scrutiny."

"Be careful of how your advisor gets paid. Conflicts of interest can yield advice that is not in your best interest."

"Making good investment decisions means recognizing that you will more often than not, end up with a different outcome than the expected result."

"There are many ways to measure risk other than looking at just the volatility of returns."

"Good decisions do not always result in good outcomes and bad decisions do not always result in bad outcomes."

"Be aware that high returns almost always come with substantial risk exposure, even when it may not be visible in the historical record."

"There is no free lunch--risk always accompanies expected returns.

"One of the biggest mistakes that investors make is relying too much on history and past performance in making decisions."

"We often find patterns where there are no patterns to be found."

"Even in a world populated by managers with no investment skill, we would still expect to see examples of long streaks of outperformance purely due to chance."

"When it comes to predicting the future, the market is usually smarter than any one person, no matter how astute or educated."

"With the rapid development and application of technology and computing to financial trading, markets are almost certainly becoming more efficient over time."

"Standard financial economic theory dictates that the 'market portfolio' is efficient and that it has the highest expected return of any portfolio for that level of volatility."

"Time is your friend when funding future goals. The earlier you start, the less you will have to save."

"Figure out what kind of portfolio you want and stick with that strategy. Getting cute with jumping in and out of the market rarely pays off."

"A study of investor behavior by the research firm DALBAR found that market timers in stock mutual funds lost -3.29% per year on average relative to investors who pursued a consistent strategy."

"By far, the most risky assets typically held by everyday investors are individual stocks themselves."

"Growth stocks have higher expected returns than value stocks. -- This may seem surprising given the mountain of literature in recent years proclaiming the benefits of value investing."

"When deciding on an asset allocation, start with the market portfolio allocation and tilt away from it toward higher or lower expected return mixes, depending on your time horizon and risk tolerance."

"Selecting an appropriate risk level for your investments is one of the most important and daunting decisions in personal finance."

"A major breakthrough in personal investing has been the development of sophisticated simulation engines that enable investors to directly observe not just the expected value of an investment, but the full range of potential outcomes."

"It pays to be skeptical when considerig the claims of someone who says he or she has a sure-fire way to beat the market."

"Pick a level of risk that you are comfortable with and stick with it. Don't fall victim to the siren song of market timing."

"For the vast majority of individual investors, buying individual stocks to achieve investment goals is inefficient, risky, and costly."

"Unlike a mutual fund, it is quite possible for a single stock to lose all its value by going bankrupt."

"Never make the critical mistake of being too concentrated in your employer's stock."

"No matter what the order of returns, the impact of volatility over time lowers the cumulative rate of return."

"Never make the mistake of assuming that a great company implies a great stock."

"On average, the performance of a broad-based index will exceed the returns of a single-stock strategy about 60% to 75% of the time over a multiyear period."

"The majority of individual investors profoundly underestimate the role that costs play in picking good investments."

"Try to invest in low-cost no-load funds when possible."

"Fund expenses are like termites. They can quietly eat away at the returns of your investment without you even realizing there is a problem."

"From the analysis of 22,472 mutual funds--only about one quarter of mutual funds were able to demonstrate performance that exceeded what you could achieve with a low-cost index fund."

"Asset class diversification is important, but so is appropriate investment selection, especially when it come to considering the impact of fees, manager performance, and taxes."

"Evaluate diversification at the household level, not at the individual account level."

"The expected return impact of giving up a single asset class is considerably less dramatic than you
might expect."

"More than half of all commercial real estate in the United States is owned by large, publicly traded corporations."

"If you own a home already, you probably have enough real estate in your household portfolio."

"After deducting costs, you can make a strong argument that many commodity investments actually have negative expected returns."

"Keep investments in alternative investments like real estate, commodities, and hedge funds to a small part of your portfolio if you choose to hold them."

"Good funds are not defined by how well they have performed in the past, but how well they are likely to perform in the future."

"Asset allocation explains more than 90% of the variation in returns for most mutual funds."

"On average, the impact of an additional 1.0% in higher fees is 1.0% lower expected return."

"You are virtually guaranteed to outperform more than two-thirds of the actively managed funds with low-cost index funds."

"Saving money to achieve financial goals is a tug of war between current wants and future needs."

"Giving up $100 per month today means a good chance (in 30 years) of having $500 per month in additional retirement income for life."

"Dropping dead early does not pose much of a financial issue, but living too long can be a real pain in the pocketbook."

"If you could accurately predict your lifespan, future inflation, and future investment returns, then it would be a trivial calculation to determine what retirement income could be supported from a given portfolio value."

"It is very expensive to guarantee that you will have a certain amount of money in the future, but if you can tolerate some uncertainty, you can likely fund your future goal with significantly less savings."

"The only way to be more confident of reaching a financial goal is to invest more conservatively and save more."

"Higher-risk portfolios yield higher expected returns and growth rates. But this higher expected performance comes at the cost of a wider range of possible outcomes."

"Perhaps more than any other factor, the presence of taxes means your investment strategy must be tailored to your personal circumstances."

"All other things held equal, it will cost a woman more to fund her retirement than a man of the same age due to her longer expected lifespan."

"It has only been in the last decade or so that typical individual investors have had access to high-quality investment advice on how to build and manage tax-efficient investment portfolios."

"There are two basic principles that govern how to invest tax-efficiently: 1) It is better to pay taxes in the future rather than today. 2) Paying lower tax rates is generally better than paying higher marginal income taxes."

"Hold less tax-efficient assets (e.g.taxable bonds) in a tax-deferred account and more tax-efficient assets in your taxable account."

"As an investor, you want to be cautious about investing in a fund just prior to it making a distribution to shareholders."

"Municipal bonds are only attractive to those investors whose tax rates are high enough so that the tax benefit outweighs the lower interest rate paid by the bonds."

"Index funds are typically much more tax efficient."

"There is no silver bullet for maximizing after-tax returns, but by paying attention to a few key factors, you can make a big difference in your financial outcomes."

"Use your common sense. If something sounds too good to be true, it almost certainly is."

"And remember that life is what happens along the path toward your future goals. Don't forget to enjoy the journey!"


Thank you Mr. Jones!

Use the link below for more "Investment Gems":

http://www.diehards.org/forum/viewtopic.php?t=881

Best wishes.
Taylor
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Postby AzRunner » Mon May 05, 2008 11:52 pm

Taylor,

Thanks for the list of gems from this book. Most of the points ring true to me.

I don't really want to get into a debate on the topic, but I wonder what the data is to support the statement,

"Growth stocks have higher expected returns than value stocks. -- This may seem surprising given the mountain of literature in recent years proclaiming the benefits of value investing."


Norm
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Postby Sphinx » Tue May 06, 2008 2:03 am

Thank you for posting these gems.

I have a newbie question about this quote:

"No matter what the order of returns, the impact of volatility over time lowers the cumulative rate of return."


Can the higher ups-and-downs of international investing reduce its potential long-term return? If so, I can see why folks shy away from international allocations higher than 40% of equities.

:?:
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How about these?

Postby zalzel » Tue May 06, 2008 2:24 am

Hi Taylor.

Great list. It is so easy to lose sight of the fundamentals. How about these?

    "Underestimating one's likelihood to panic at a time of market stress is the first step on the sell-low/buy-high cycle of fear, capitulation and loss."

    "The investor who carefully considers his capitulation risk, and strives to lower it to zero, can expect to do well."

    "The investor, in his long term relationship with his portfolio, would do well to remain faithful."


:),

Z.

P.S. Those are all mine. How about soliciting submissions for a 'Boglehead pearls of wisdom' list?
"What we can't say we can't say, and we can't whistle it either." | Frank P. Ramsey
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Postby wearethefall » Tue May 06, 2008 7:59 am

Could you please post a quick review of the book?

Thanks.
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Editorial Review

Postby Taylor Larimore » Tue May 06, 2008 10:34 am

wearethefall wrote:Could you please post a quick review of the book?

Thanks.


You will find this Editorial Review at Amazon helpful and better than I can do:

http://www.amazon.com/Intelligent-Portfolio-Practical-Investing-Financial/dp/0470228040

Best wishes.
Taylor
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Additional information

Postby Taylor Larimore » Tue May 06, 2008 11:05 am

AzRunner wrote:Taylor,

Thanks for the list of gems from this book. Most of the points ring true to me.

I don't really want to get into a debate on the topic, but I wonder what the data is to support the statement,

"Growth stocks have higher expected returns than value stocks. -- This may seem surprising given the mountain of literature in recent years proclaiming the benefits of value investing."


Norm


Hi Norm:

I'll add a few paragraphs:

"Table 4.4 shows the estimates of asset class expected returns based on information from the Financial Engines model as of January, 2007."

"Growth stocks have higher correlations with the overall market, higher volatilities, and hence higher expected returns. This is not to say that you should prefer growth stocks over value stocks in your portfolio, as value stocks also come with lower volatility and lower correlations with the overall market, but if higher expected returns are your goal, a growth-oriented portfolio will provide higher exposure to market risk.

There is an argument that value stocks have additional risk that is not fully captured by the volatility of returns. Value stocks tend to reflect companies that have lower market values relative to thier accounting values (often companies in distress), and hence may be more subject to financial dislocations (bankruptcy) if conditions suddenly worsen. Such securities may do proportionately worse in very bad times than more healthy companies. This type of 'peso problem' risk may not show up often in historical returns, but it may be anticipated and priced by the market and hence impact expected returns. Such an argument hinges on the correlations for value stocks with the market being higher when times are very bad (e.g., a depression)."


As you stated, this is not the place for a debate.

Best wishes.
Taylor
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Postby wearethefall » Tue May 06, 2008 2:08 pm

This certainly looks interesting, thanks.
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Postby AzRunner » Tue May 06, 2008 3:27 pm

Taylor,

Thanks for the backup material and the even handed treatment that the author provides.

Norm
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Postby RTR2006 » Tue May 06, 2008 3:40 pm

Taylor, thanks for bringing this book to our attention and for posting these gems!

Just one more reason why I love this forum...

RTR
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Postby canyon » Tue May 06, 2008 5:24 pm

In addition to the information outlined throughout these pages, readers may also become a user of the online advisory service at FinancialEngines.com for one year, so that they may apply what they’ve learned to their own personal investment portfolios.


This quote was taken from the review on Amazon.com. Anyone know anything about the FinancialEngines.com and whether this offer could be useful?
In any case, thanks Taylor..the book looks interesting and worth a look.
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Postby ken250 » Tue May 06, 2008 5:53 pm

Small companies may be subject to some of the same risks in very bad times that value stocks are subjected to.

Here's a good one for the author...

VG's MGC ETF, MegaCap 300, Median Market Cap = $58.5 B

VG's MGK ETF, MegaCap 300 Growth, Median Market Cap = $45.3 B

VG's MGV ETF, MegaCap 300 Value, Median Market Cap = $105.8 B

BigFoot no want debate.
Last edited by ken250 on Tue May 06, 2008 6:13 pm, edited 4 times in total.
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Postby Taylor Larimore » Tue May 06, 2008 5:55 pm

canyon wrote:
In addition to the information outlined throughout these pages, readers may also become a user of the online advisory service at FinancialEngines.com for one year, so that they may apply what they’ve learned to their own personal investment portfolios.


This quote was taken from the review on Amazon.com. Anyone know anything about the FinancialEngines.com and whether this offer could be useful?
In any case, thanks Taylor..the book looks interesting and worth a look.


Vanguard is one of Financial Engine's customers. This link describes their service:

https://personal.vanguard.com/us/accounttypes/advice/ATSAdviceInvAdvOnlineContent.jsp

Best wishes.
Taylor
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Postby wearethefall » Fri Jun 13, 2008 6:04 am

This has been a really refreshing read so far. It is a very Bogleheads type book, but unlike many others is outside of the Fama French paradigm. The author uses a process called reverse optimization - assuming the market portfolio is efficient, and using this to find the expected returns of various asset classes. This results in growth having a higher expected return than value, the opposite of Fama French and what many on this board take for granted.

I'm not saying that either of these asset pricing models are correct, but it has cast more doubt for me on value tilting and has reaffirmed my convinction to stick with TSM.
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Postby PaPaw » Fri Jun 13, 2008 9:57 am

canyon wrote:
In addition to the information outlined throughout these pages, readers may also become a user of the online advisory service at FinancialEngines.com for one year, so that they may apply what they’ve learned to their own personal investment portfolios.


This quote was taken from the review on Amazon.com. Anyone know anything about the FinancialEngines.com and whether this offer could be useful?
In any case, thanks Taylor..the book looks interesting and worth a look.


I believe if you have either Voyager or Flagship status at Vanguard, you can access Financial Engines for free.
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Re: "The Intelligent Portfolio" -- A Gem

Postby peter71 » Fri Jun 13, 2008 10:19 am

Taylor Larimore wrote:
"There is no free lunch--risk always accompanies expected returns.



I'm not crazy about the way this one is phrased. While theoretical economists often assume that everything's a "risk premium" for simplicity's sake, I think Fama is correct in pointing out that there's quite possibly more to it than that -- including investor "tastes" for different types of lunches. Particularly when we think of actual funds rather than theoretical assets, moreover, I think there's all sorts of reduced-price lunches, including those for big investors like Admiral shareholders and those for people who buy index funds from VG rather than from companies charging more for the same product.

All best,
Pete
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Postby stratton » Fri Jun 13, 2008 10:24 am

"Municipal bonds are only attractive to those investors whose tax rates are high enough so that the tax benefit outweighs the lower interest rate paid by the bonds."

For the last several months this hasn't been true. Treasuries were yielding less than municipals. Right this moment its still true, but it might not be for long as Treasury yields appear to be rising.

Another gem might be, "Investors who follow rules of thumb without looking can get burned."

Paul
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Postby Cloud » Sat Jun 14, 2008 11:55 pm

canyon wrote:Anyone know anything about the FinancialEngines.com and whether this offer could be useful?


Thanks Taylor for the book info...

Wow, I keep learning more every day about how great one of our 401K plans is. One Employer plan gives us free Financial Engines access!

You enter all your info, assets, accounts, retirement age, income desired, etc. Then Financial Engines will run a Monte Carlo simulation showing you the % chance of retiring at age X with income of X. It also shows projected upside, ave, and downside incomes. They use their own models of interest rates, returns, and inflation as they are not user changeable. Financial Engines will even give you suggestions to improve your plan.
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Postby sopogah » Sun Jun 15, 2008 3:01 pm

Thank you Taylor for another great post.

You Gem's are the the best read ever. They are concise, informative, and it is my guide to the books that worth reading. (which I eventually do).

Thanks again.

Jack

_________________________________________

Money is a good servant, but a bad master.
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Postby SmallHi » Sun Jun 15, 2008 3:14 pm

wearethefall,

I'm not saying that either of these asset pricing models are correct, but it has cast more doubt for me on value tilting and has reaffirmed my convinction to stick with TSM.


I just want to be the first to thank you for buying my larger, more growth oriented stocks from me once its finally time for them to be purged from my small/value tilted portfolio! :lol:

this has to be one of the first times I have ever heard of a growth premium being taken seriously (outside of conferences for growth active managers!)

sh
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Postby wearethefall » Mon Jun 16, 2008 6:13 am

Read the book. As a value tilter you should always be looking for evidence that contradicts your hypothesis.
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Postby LHerr » Fri Jun 27, 2008 7:50 pm

"Could you please post a quick review of the book?"

Here is a partial review.

http://www.lherr.org/blog/?s=Intelligent+portfolio

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Postby ken250 » Fri Jun 27, 2008 9:59 pm

wearethefall.

I think the reason why the author says growth stocks do better than value stocks is because he works with Sharpe, of CAPM fame, and is probably convinced beta is the ultimate risk metric...and many growth stocks/funds have high betas...higher beta = higher return.
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Postby LHerr » Sat Jun 28, 2008 8:46 am

"I think the reason why the author says growth stocks do better than value stocks is because he works with Sharpe, of CAPM fame, and is probably convinced beta is the ultimate risk metric...and many growth stocks/funds have high betas...higher beta = higher return."

Ken,

I too suspect it is the Financial Engines optimization tool that is projecting growth to outperform value. Combine the projection and Jones' distaste for historical information and one might come to that conclusion. Who is to say the engine is pumping out the correct information.

My major beef with the book is the emphasis on actively managed funds rather than using index funds or ETFs to populate the portfolio. I have yet to read the entire chapter on "Picking The Good Ones," but I will hold my nose as I read that chapter.

One of the reviewers on Amazon wrote that the book recommends not rebalancing. I have yet to find that in the book. Would you or anyone else know where that information is located. Again, I would like to see the data to support this position. I've found that if one does not rebalance, the market will eventually do it automatically.


LHerr

http://www.lherr.org/blog/
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Postby Sammy_M » Sat Jun 28, 2008 9:28 am

PaPaw wrote:I believe if you have either Voyager or Flagship status at Vanguard, you can access Financial Engines for free.


Has anyone used the FinancialEngines tool thru Vanguard? Is the advice rendered any good?
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