Unusual inquiry

cagedbirdIt’s not every day I get a solicitation for investment advice from someone in a Federal correctional institution. Here is my reply:

Dear John,

Thank you for your letter regarding investment information. I would be happy to provide investment advice to you; although it might be difficult to do so until your release. I have enclosed, for your information my booklet “Understanding Mutual Funds”. I hope you will find it interesting and useful.  

I am starting with this topic because as a rule I only use mutual funds in my client portfolios. I have created 6 investor profiles which serve clients in a range of those who desire to have very little risk for losing their money through those who wish to have more risk because of the promise of greater returns it brings. Keep in mind that even my most risky profile is only moderately risky in the scheme of things. Mutual funds provide instant investment portfolios that are selected by competent money managers supported by staffs of analysts who spend all their days researching companies. I take advantage of this very low cost way to access extremely valuable opinions by simply investing in their mutual funds.  

Mutual funds are an important tool for me but they are not my investment philosophy. The philosophy I have adopted for my practice is called “Modern Portfolio Theory”. It is the only empirical study of investing that I know of. Its researchers won the Nobel Prize for economics. I won’t go into it in detail here but I can recommend a couple of useful books for you. One is “The Four Pillars of Investing” by John Bogle. You might recognize his name since he is the founder of Vanguard Funds. The other book is called “The Wealthy Barber”. This is a book spawned by the PBS series by the same name. The Wealthy Barber is a great guide to anyone who wants to grow rich over their lifetime. It is not a guide to getting rich quickly, however. 

I hope my response to your letter will offer you some cheer in what must be a very dismal and dreary existence. Keep in mind, where there is life there is hope. 

Yours Truly,

Rebalance your portfolio in the face of the storm

Calm in the face of the storm

Please find this very good article from the New York Times (via the Arizona Daily Star) that helps to put the current market instability into perspective. The article points out that retirement portfolios usually take years or even decades to come to fruition, so it suggests that impulsive moves to cut losses by selling stocks may hurt retirement portfolios that an investor may need to rely upon for 30 years.

Here, at Jim Hannley LLC we were busy during this upset examining our client accounts to determine which, if any of our allocations needed to be rebalanced. (For more detailed information about rebalancing; especially how tactical and strategic rebalancing differ, please find that elsewhere on our site.) Not surprisingly, due to the sharp sell off of equities last Friday and Monday, we found that our allocations to our large cap funds, our international funds, our emerging markets funds (both equities and fixed income) and our core bond funds had moved away from their target allocations. In response, we placed many orders to buy or sell these funds to restore their model allocations.

This is strategic rebalancing because we are not increasing or decreasing our allocations away from our models (sometimes referred to underweighting or overweighting an asset class) by speculating that one asset class or another will be a winner or a loser. However, this does not mean that strategic rebalancing cannot result in a short term gain. For instance, if we find that the AJAX large cap fund is down 2% and, as a result, our 20% allocation to AJAX as our Large Cap vehicle is now 19.6%; we will buy more AJAX to restore it to 20%. This means that in a $100,000 portfolio AJAX, for example, prior to the event was selling at $10/unit and it is now selling at $9.80 we might need to buy $400 of AJAX to bring the AJAX allocation of $20,000 from $19,600 back to $20,000. We now own 40.8 more units of AJAX than we did before the event. If the price of AJAX cycles back up to $10.10/unit we find that we now hold 2040.8 units with a value of $20,612. If we rebalance once again, we will sell 60.6 units for $612 and realize a short term gain of $212 ($612-$400).

Conversely, because our international, domestic and emerging markets equities are collectively down 4% in the portfolio, our fixed income allocation has grown from 30% to 31.25% (up 4%) in our depressed portfolio now valued at $96,000. The fixed income fund has not increased its share price, but its proportional amount to the entire $96,000 portfolio has increased. We are going to have to sell $1,250 of our bond fund to bring the bond fund from $30,000 to $28,800 ($28,800/$96,000 = 30%). We now have another $1,200 in cash with which to buy more equities while their share prices are (temporarily) depressed.

This exercise will, hopefully demonstrate that roiled markets bring investment opportunities to investors who know how to strategically rebalance their portfolios to take advantage of price changes in their funds.