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Monday, November 09, 2009


Target Date Funds

Recent experience (2008, 2009) has shown that target date funds have glide paths (stock/bond allocation over time) that turned out to have more equity exposure than people were comfortable with. People who were couple of years away from retirements, or had 529 with kids couple of years away from college, found themselves in target date funds with 60-70% equity exposure and lost 25-35% in 2008. Also, most target date funds have a high equity exposure in early years and many people may not be comfortable with putting in large lump sums when the equity exposure is that high.

One way to adjust the risk in a target fund is to combine it with a balanced fund. For example, a 529 target date fund for a baby may have a glide path of 90/10==>10/90 over 15-18 years. People may hessitate to put in a lump sum when the initial allocation is 90/10. Combining it with a moderate allocation (60/40) balanced fund in EQUAL amounts will result in an effective glide path of 75/25==>35/65. By having other appropriate ratios of target date fund and balanced fund, one can find a portfolio glide path that may be more comfortable.

Thursday, November 05, 2009


Was 2008 Really a Black Swan Event?

No! It was just a 2-3 STD_DEV (SD) year.

Under idealized assumptions (although that is not the market), with respect to averages:

+/- 1SD covers 68.26% of possible outcomes; so 15.87% of outcomes can be above +1SD and 15.87% of outcomes can be below -1SD (ie disaster once in 6.3 periods).

+/- 2SD covers 95.44% of possible outcomes; so 2.28% of outcomes can be above +2SD and 2.28% of outcomes can be below -2SD (ie disaster once in 43.86 periods).

+/- 3SD covers 99.73% of possible outcomes; so 0.135% of outcomes can be above +3SD and 0.135% of outcomes can be below -3SD (ie disaster once in 740.74 periods).

With moderate allocation balanced funds having SD of 10-14% annualized, a "-2SD event" could cause losses of 20-28% sometime in 43.86 years and that turned out to be 2008.

With conservative allocation balanced funds having SD of 7-10 annualized, a "-2SD event" could cause losses of 14-20% sometime in 43.86 years and that did happen in 2008.

So as painful as 2008 was, it wasn't totally beyond the realm of possibilities.

Lesson then is to control portfolio risk to one's comfort zone.

Tuesday, February 06, 2007


Response to Kiyosaki's Article

Response to "Mutual Funds Get Greedy" by Robert Kiyosaki

"yogibearbull, yogibearbullDSL - Tuesday, February 6, 2007, 4:43AM ET
Overall: 2/5
Study that an average mutual fund investor made only 29,700 in 20 years on 10,000 investment, instead of 109,800, made certain assumptions on the market timing behavior of mutual fund investors based upon mutual fund flows data. If an investor kept money in a no load index fund, or middle of the road growth and income fund, throughout the 20 year period, fund investor would have indeed made the higher amount after giving up well under 1% in annual fund expenses."


Wednesday, April 19, 2006


Gold in Portfolio

Every US portfolio should be hedged for dollar’s value to a reasonable extent. This can be done by holding hard assets (precious metals, commodities, real estate); related instruments: PM stocks and funds, REITS; international stocks and bonds; and TIPS. Gold should play an important role in this dollar-hedge portion of the portfolio.

Gold has a long history. Let us pick up the thread in 2000. London fixings for gold in 2000 ranged from $263.80-312.70 (average $279.11; source http://www.kitco.com/ ). Silver was not doing well either—after a brief spike in early 1998, its London fixes in 2000 ranged from $4.5700-5.4475 (average $4.9506). Gold had been in relentless decline. Central bank sales, forward selling of production by mining companies, strengthening dollar, and the constant drumbeat of “gold is dead money” had depressed gold. Even the bursting of the internet bubble (2000-02) was not able to wake gold up from its slumber. In this extremely negative scenario, an interesting book on gold by a mainstream author (Peter Bernstein) and mainstream publisher (J. Wiley) came out in Fall 2000 (Peter L. Bernstein, The Power of Gold, J. Wiley, 2000). The following review that I wrote at the time can still be found online through Google or Yahoo search on my assumed name “yogibearbull.”

“From reader yogibearbull in IL, September 27, 2000; Reviewer: A reader

Bernstein's The Power of Gold has moved from #3732 (9/22/00)to #94 (9/27/00)in Amazon sales rank!--this is simply amazing for a book on the yellow metal which has supposedly lost its luster. Book's official publication date is just this month--September 2000. It may soon hit the bestseller list at this rate.

Bernstein tells a story which is shocking, gory, fascinating, and interesting. It has weak beginning and end, but great middle. Items are well referenced and footnoted. Bernstein does not have a pro or con view on gold as an investment in this book, but he seems skeptical of the current paper currency system and the gold situation. He does not believe that we have seen last of the gold story.

I think that any one reading the book will be motivated to have some exposure in gold as a hedge for the unknown future. Tales in the book describe the fate of those who failed to hedge and got caught up with the fads of their times.”

Now switch to 2006. At the time of this writing (April 2006), all negative factors in 2000 have turned around 180 degrees and there are several geopolitical concerns. Sentiment and press for gold and silver has become very positive. On April 19, 2006, a particularly wild day, London fixings were $624.75 for gold and $14.27 for silver, and spot gold and silver continued to dash past London fixings.

People should continue to follow the portfolio strategy of holding precious metal assets as part of the dollar-hedge portion of the portfolio although some adjustments may be necessary.

There are many ways now to have exposure to gold. Gold stocks and gold mining mutual funds are extremely volatile, but mutual funds at least reduce company specific risk. Some examples of open-end gold funds are BGEIX (American Century), FSAGX (Fidelity), UNWPX (US Global), VGPMX (Vanguard). Among exchange traded funds are GLD (gold), IAU (gold) and soon to be available SLV (silver). Closed-end funds include CEF (holds gold:silver in 1:50 ratio by weight) and GGN (holds stocks related to gold, energy and other natural resources). Futures and options markets offer many specialized tools, including index options on ^XAU. Several bullion dealers offer bullion accounts. There are few gold-based payment systems such as http://www.goldmoney.com/ and http://www.e-gold.com/. These vehicles, old and new, can now accommodate individual as well as institutional investors. They have brought ease of access and visibility to precious metal investments. So the demand is no longer limited to holdings by the gold bugs and individual holders in Asia and Middle East.

Other Tidbits:
12 Troy Ounces of gold make 1 Troy Pound of gold (unlike the usual 16 Oz of peanuts for 1 Lb of peanuts).
1 Troy Oz of gold has 31.1034768 grams of gold (1 Oz of sugar has 28.350 gm of sugar)
1 Tonne = 1,000 KG = 1,000,000 gms = 32,150.7465686 Troy Oz
1 Tola = 0.375 Troy Oz = 11.6638038 gm (definition varies)
Gold is 19.32 times heavier than water, silver is 10.49 times heavier (specific gravities)
1 cubic meter of gold is 19.32 Tonnes
24 Karat gold is 100% pure; 18 Karat gold is 75% pure (100x18/24 %)

Friday, April 07, 2006


Stock Risks - Relative and Absolute

There are several measures of risks. Many outfits create their own proprietary measures of risks to confuse things further. Here is an explanation that is simple and moderately technical.

Relative risk, also called market risk, of a stock or stock fund with respect to an appropriate broad index is called BETA. For example, if a US stock fund changes by 4% when SP500 Index changes by 5%, then the fund BETA is “approximately” 0.8 (= 4/5). By definition, index BETA is 1.0. Choice of an appropriate index is important. While SP500 Index is appropriate for US stocks and stock funds, EAFE Index is appropriate for international stocks and stock funds. While BETAs for international stocks can be computed against SP500 Index, such BETAs are less useful and must be interpreted carefully; correlation factor is useful in such interpretations but that would be the subject of another mote technical posting.

Precise determination of BETA involves comparison of, say, monthly percent changes in a stock fund with those in the index over, say, a three-year period. Then using simple statistical analysis (linear regression), BETA and ALPHA are determined to satisfy the following relationship:

(% monthly change in stock fund) = BETA x (% monthly change in index) + ALPHA

ALPHA is taken as an indication of fund management’s savvy because it represents return over or under what can be expected based upon BETA alone.

ALPHA = (% monthly change in stock fund) - BETA x (% monthly change in index)

Positive ALPHAs are supposed to be good, while negative ALPHAs are supposed to be bad. Well, that is the theory. In practice, BETAs tend to persist over time and do contain useful information. But ALPHAs tend to fluctuate a lot and are less useful. Also, most aggressive stock funds have negative ALPHAs while many conservative balanced funds with 40% or less stocks have positive ALPHAs. This does not mean that all conservative balanced funds are better managed than all aggressive growth funds. So, comparing ALPHAs works only within a peer group.

If the market went down 30% and your fund with BETA of 0.8 went down 24%, should you be happy? Yes and no. Yes, because your fund delivered the expected performance – no more and no less. But that will hurt because 24% loss is a big hit in an absolute terms for most of us. How to control this absolute risk? That is through standard deviation (STD_DEV or SIGMA). It is a measure of how much, say, monthly returns deviate from the average monthly return over, say, a three-year period. No distinction is made among positive and negative deviations, and no benchmark index is involved in its determination. Under ideal conditions – that never exist in practice – prices will be contained between AVG (+/- ) STD_DEV for 68.26% of the time, or for simplicity, two-thirds of the time. Prices will be contained between AVG (+/- ) 2 STD_DEV for 95.44% of the time – this is the rationale for Bollinger Bands in that once the price moves out of 2 STD_DEV band around moving AVG, the fund is way overpriced or underpriced, although the time frame is for daily pricing over a few days only (20 days in Yahoo Finance). Standard Deviation also tends to persist over time but it does fluctuate. For SP500, standard deviation is typically in 15-20% range (annualized) although in some three-year time frames, it can be around 10% (annualized) only. Standard Deviations can be determined for any asset class: stocks, bonds, TIPS, REITs, money market instruments. Because its determination is independent of any benchmark index, standard deviations can be compared across different asset classes. They are the highest for sector funds and negligible for money market instruments.

You can therefore control absolute risk through standard deviations. If the general stock market standard deviation is 18% (annualized), and general bond market standard deviation od 4%, a conservative investor can mix stocks, bonds and money market instruments to have a portfolio standard deviation of 8-10% (annualized); this is achievable with 50-50 stock-bond mix. An extremely conservative investor may limit portfolio standard deviation in 6-8% range (annualized); this is achievable with 20-80 stock-bond mix. Intermediate bonds are best for portfolio construction. Long term bonds are bets upon interest rate changes and do not have a good risk/reward in general. Junk bonds have standard deviations comparable to equities so they really belong in stock category, not in bond category.

If you are super aggressive, then you can have sector funds that have standard deviations of 2-3 times of the general equity market (i.e., STD_DEV of 40-60% annualized), or you can use leverage (margin) to increase standard deviation of an otherwise normal portfolio. One approach employed by hedge funds is to construct a low risk “sure fire” strategy and then use large amounts of leverage (e.g., 4:1 debt:equity). But in reality, there is nothing that is “sure fire,” and hedge fund performances are all over the board. Many hedge funds have just collapse spectacularly because things went the other way to their supposed "sure fire" way. And some times people can get too greedy, and put too much weight on the advice of Noble Laureates or capability of quants – remember LCTM that had 40:1 debt:equity that was made possible by extreme secrecy?

Serious investing is all about controlling risks, and not about maximizing profits. If you manage risk to your comfort level, you would be well rewarded for staying the course. Within your level of risk, you can adjust the portfolio mix, change the nature of stocks and bonds that you hold, and trade moderately, so this is not a buy and hold approach.

Where do you get some of this information at low or no cost? From Yahoo Finance, AAII, and Morningstar. There are many subscription-based services that will also provide this type of data.


Thursday, April 06, 2006



Treasury Inflation Protected Securities (TIPS) are a new type of bond class that have been available since late 1990s. Their total return has two parts: real return based upon current interest rate environment, and inflation adjustment of principal based upon CPI-U (urban). Food and energy are included in CPI-U, unlike the core CPI that excludes them.

Difference between the current yield of regular treasuries (T-Notes/Bonds) of comparable maturities and TIPS current yield is the current inflation expectation for future. If the actual inflation turns out to be more that the current inflation expectation, then you win with TIPS; otherwise, you win with regular treasuries.

It is then possible to mix regular treasuries and TIPS to create an inflation neutral bond portfolio.

You can hold TIPS in brokerage accounts, Treasury Direct accounts, or as mutual funds. If you hold individual TIPS bonds, then you get 1099-INT for annual interest, and 1099-OID for annual inflation adjustment of principal; you have to pay federal income tax on both even though you don’t get cash payout for annual principal adjustment. It is therefore preferable to hold TIPS bonds in tax advantaged accounts. If you buy TIPS mutual funds, then the funds pay out interest and principal adjustments as annual distributions.

A related product is I-Bonds. It has a fixed base rate and inflation adjustment based upon CPI-U. Uncle Sam has been stingy in setting I-Bond base rate. In the current low interest rate environment, don’t buy EE-Bonds because now their rate is fixed at the time of purchase. Many people who have been buying EE-Bonds through payroll deductions have not realized that rules have been changed for worse. A great advantage of Savings Bonds is that they don’t generate any paper trail and only you and Treasury, and IRS at the time of sale, know about them. This is a good way to stash away some money that a spendthrift or problem partner knows nothing about.


Sunday, November 27, 2005


Income Strategy

There have been many articles that show that high fixed withdrawal rates can exhaust an account prematurely. A simple solution would be to withdraw a fixed percentage (4-5% per year) of the current value of the account. Yes, the amount withdrawn will fluctuate, but that can be managed by controlling volatility of the account by using a balanced approach (e.g., 50/50 to 25/75 stock/bond mix). One problem is that many financial institutions don't allow automatic withdrawals using fixed percentages.

A self managed strategy is to have separate stock and bond accounts to reflect appropriate stock/bond proportion and to set up withdrawals from bond account only. The accounts then are periodically rebalanced to keep target stock/bond proportion.

Bottom line is that income accounts should have low volatility (e.g., low standard deviation, SD).

Assuming stock SD of 20% and bond SD of 4%, 25/75 stock/bond account will have SD of ~ 8.

Total returns are not relevant for income accounts. They are relevant only for accumulation accounts.

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