Have you ever listened to the nightly business report and wondered how the newscaster determines the reason for the rise or fall of the stock market indices on a particular day? The newscaster provides cause and effect analysis on a daily basis, which presumes analytical skills beyond the average investor and an understanding of the broader economic context of that specific event. However, the newscaster does not explain either of these factors in the report. Joseph H. Ellis, the author of Ahead of the Curve, contends that most reports listeners hear have no basis in analysis or no relationship to actual occurrences of economic business cycles or the stock market.
In the Preface of the book, Ellis explains the basic theses of the book: the business cycle and its cause and effect relationships, the repeatability of which allows individuals to extract forecasts. Secondly, Ellis highlights some fallacies in common conceptions of the leads and lags in economic cycles. Unlike many economic commentators, he classifies a recession as a lagging indicator as well as employment and capital spending. He designated declines in consumer spending and hourly earnings as leading indicators. Finally, Ellis discredited month by month and quarter by quarter analysis as confusing and out of context. He preferred a year-over-year analysis of an economic cycle, which he called the ROCET--rate of change in economic tracking.
Presenting a statistical analysis of business cycles, Ellis clearly identifies independent variables and
related dependent variables. This approach simplifies the understanding of economics and allows
the reader to view economics in its basic elements, at the macro and micro level. Like Ellis, I wish that my Intro to Economics had started with this perspective and built the course from there. The next step, applying the method.
For the reader, Ellis publishes economic data on his website, http://www.AheadoftheCurve-theBook.com
Friday, December 13, 2013
Friday, August 23, 2013
Standard and Poor's Guide to the Perfect Portfolio : Five Steps to Allocate Your Assets and Ensure a Lifetime of Wealth
Michael Kaye, a portfolio officer at Standard and Poor's, cites studies that documented the importance of asset allocation over individual stock selection. He defined asset allocation as "the process of determining the optimal way to divide a broad range of categories of assets (stocks, bonds, cash, and others) in a way that suits your investment time horizon and risk tolerance" (p. 10). To make this investment decision, he itemized 5 steps: "Step 1: Identify your goals and objectives; Step 2: Choose the specific asset classes in which to invest; Step 3: Determine what percentage of your total assets belongs in each asset class; Step 4: Decide which investment products to use; Step 5: Monitor the performance of your portfolio and adjust your asset mix if warranted" (p. 13).
Of the common types of asset allocation approaches, the buy and hold strategy becomes the default position. Because after the initial purchases the investor takes no action, transaction costs remain low and the asset allocation can veer far from its original makeup. A less familiar approach to the average investor but one that many unconsciously follow, insured asset allocation strategy, entails selling assets that reach the floor in value and buying more assets that appreciate. As Kaye states, "insured asset allocation assumes that your risk tolerance changes with your level of wealth. You have no tolerance for risk below the floor value and an increasing risk appetite above the floor value" (p. 12).
With strategic allocation, the investor decides what percentages he or she designates for each asset class and rebalances periodically to maintain those percentages. Only because of changing goals or events, does the investor change the percentages. This approach accrues greater transaction costs than buy and hold and, like buy and hold, favors a long-term strategy. Tactical allocation, more short-term oriented, opportunistic, and riskier than strategic allocation, results in a change of percentages based on market conditions. Transaction costs grow from the time taken to follow market trends and the increased costs to buy and sell.
Of the common types of asset allocation approaches, the buy and hold strategy becomes the default position. Because after the initial purchases the investor takes no action, transaction costs remain low and the asset allocation can veer far from its original makeup. A less familiar approach to the average investor but one that many unconsciously follow, insured asset allocation strategy, entails selling assets that reach the floor in value and buying more assets that appreciate. As Kaye states, "insured asset allocation assumes that your risk tolerance changes with your level of wealth. You have no tolerance for risk below the floor value and an increasing risk appetite above the floor value" (p. 12).
With strategic allocation, the investor decides what percentages he or she designates for each asset class and rebalances periodically to maintain those percentages. Only because of changing goals or events, does the investor change the percentages. This approach accrues greater transaction costs than buy and hold and, like buy and hold, favors a long-term strategy. Tactical allocation, more short-term oriented, opportunistic, and riskier than strategic allocation, results in a change of percentages based on market conditions. Transaction costs grow from the time taken to follow market trends and the increased costs to buy and sell.
Wednesday, August 21, 2013
Why Tinkering Too Much with Your Portfolio Won't Pay Off
I found the title of this article, circulated on the Australian School of Business newsletter, intriguing. In the age of day traders, I constantly wonder if monthly I should evaluate my portfolio strategy. This article and the research paper that it explains provided an academic view of the issue.
Andrew B. Abel, Janice C. Eberly, and Stavros Panageas, professors at Wharton, Kellogg, and the Booth School of Business at the University of Chicago wrote a highly technical paper entitled, Optimal Inattention to the Stock market with Information Costs and Transaction Costs http://www.nber.org/papers/w15010.pdf?new_window=1 .
The paper makes the assumption that the investor has two accounts, an investment account with equities and a transaction account, a cash account for living expenses. The paper, additionally, considered two transaction cycles or "observation dates", one that occurred at regular intervals--"time dependent", for example, a monthly withdrawal to cover living expenses; and another that occurred far less frequently--"state dependent", for example, once a decade. To assess transaction costs, the authors included two types, "the value of the investor's time, plus commissions and other charges that apply to any action taken" (p.1).
The authors identified "the period of 'optimal inattention'. "Logic says that the higher the investor's cost of time and money, the longer this period is" (p. 1) They concluded that "it would probably not pay to adjust a portfolio more often than every month or two" given commission and other fees" (p.1).
http://www.nber.org/papers/w15010.pdf?new_window=1
Andrew B. Abel, Janice C. Eberly, and Stavros Panageas, professors at Wharton, Kellogg, and the Booth School of Business at the University of Chicago wrote a highly technical paper entitled, Optimal Inattention to the Stock market with Information Costs and Transaction Costs http://www.nber.org/papers/w15010.pdf?new_window=1 .
The paper makes the assumption that the investor has two accounts, an investment account with equities and a transaction account, a cash account for living expenses. The paper, additionally, considered two transaction cycles or "observation dates", one that occurred at regular intervals--"time dependent", for example, a monthly withdrawal to cover living expenses; and another that occurred far less frequently--"state dependent", for example, once a decade. To assess transaction costs, the authors included two types, "the value of the investor's time, plus commissions and other charges that apply to any action taken" (p.1).
The authors identified "the period of 'optimal inattention'. "Logic says that the higher the investor's cost of time and money, the longer this period is" (p. 1) They concluded that "it would probably not pay to adjust a portfolio more often than every month or two" given commission and other fees" (p.1).
http://www.nber.org/papers/w15010.pdf?new_window=1
Tuesday, January 22, 2013
Charles Schwab : You're Fifty--Now What
Sometimes the most basic tasks get overlooked. Fortunately, Schwab has enumerated what one should do, no matter your age. This book offers those guidelines. I will attempt to summarize the ones I found most helpful here. Schwab divided the book into two section, Planning for the Financial Second half of your life and Putting your house in order in the second half.
Expectedly, in the first half of the book, this leader of a brokerage firm suggests that readers invest in stock. He presents the historical evidence that stock has outperformed other financial instruments in the past. Furthermore, he proposes that you invest for growth as aggressively as you can tolerate and afford. He argues that asset allocation--stocks, fixed income, and cash equivalents-- determines 90% of your long-term investment returns. Knowing your budget for this period allows you to measure actuals with inflation against budget. For starters, Schwab suggests a Core and Explore asset allocation--a combination of index funds and actively managed mutual funds and individual stocks.
After deciding a strategy, Schwab directs readers to list all their current assets--cash, IRAs, 401Ks, etc. What paperwork should you keep:
1. Tax returns with supporting documents, such as 1099s (up to six years back)
2. Settlement sheets on house closings, improvements or remodeling of the house
3. Retirement Plan records, records of contributions to retirement plans distributions, conversions, and rollovers
4. Purchase of securities that you own, purchases or gifts--for up to three years
The next step requires estimating the income you will need in retirement, after major life changes, etc. factoring in inflation and compounded interest. From there, he proceeds to go deeper into the asset allocation options--aggressive plans, moderate plans, and conservative plans, with varying degrees of each. Then we get to the point of all this planning, paying yourself from the earnings of your investments in a manner that supports your expenses throughout your lifetime. The trick, not running out of money before you run out of time--making your money outlive you with, hopefully, some to spare for progeny. The remainder of the first section deals with the mechanics of managing your portfolio--monitoring and rebalancing it--how to, the frequency, and logic.
The second portion of the book concentrates on financial advice--determining if you need it, where to get
it and the questions you should ask to assess the quality of the potential advisor. Having reviewed your assets and determining your preference for an asset allocation, you should be prepared for any questions that the advisor might ask you. Regarding the questions you should ask him or her:
"What is your education and professional background?
What is your management style and philosophy? What is the best investing decision you've make in the last five years? the worst?
How are fees set?
Do you prefer one type of investment over another?
Have you had success with clients similar to me? What has your past performance been for clients with financial objectives similar to mine?
How will you help me define my investment objectives? Will you provide a customized investment plan? How often will you review my portfolio?
Where will my assets be held?
Schwab recommends that you consider only fee-based managers. Check the fine print : Form ADV (Application for Investment Advisor Registration), required for all investment advisors who manage more than $25 million in customer assets, a registration of the SEC. Needless to say, communication with the advisor, reading and understanding all documents, openness and trust are key.
The book ends with a discussion about insurance--life, term, medical, disability, and long-term care--estate planning, and charitable giving.
**********************************************************
Schwab, C.2001. You're Fifty--Now what? Investing for the second half of your life. New York: Crown Business.
Expectedly, in the first half of the book, this leader of a brokerage firm suggests that readers invest in stock. He presents the historical evidence that stock has outperformed other financial instruments in the past. Furthermore, he proposes that you invest for growth as aggressively as you can tolerate and afford. He argues that asset allocation--stocks, fixed income, and cash equivalents-- determines 90% of your long-term investment returns. Knowing your budget for this period allows you to measure actuals with inflation against budget. For starters, Schwab suggests a Core and Explore asset allocation--a combination of index funds and actively managed mutual funds and individual stocks.
After deciding a strategy, Schwab directs readers to list all their current assets--cash, IRAs, 401Ks, etc. What paperwork should you keep:
1. Tax returns with supporting documents, such as 1099s (up to six years back)
2. Settlement sheets on house closings, improvements or remodeling of the house
3. Retirement Plan records, records of contributions to retirement plans distributions, conversions, and rollovers
4. Purchase of securities that you own, purchases or gifts--for up to three years
The next step requires estimating the income you will need in retirement, after major life changes, etc. factoring in inflation and compounded interest. From there, he proceeds to go deeper into the asset allocation options--aggressive plans, moderate plans, and conservative plans, with varying degrees of each. Then we get to the point of all this planning, paying yourself from the earnings of your investments in a manner that supports your expenses throughout your lifetime. The trick, not running out of money before you run out of time--making your money outlive you with, hopefully, some to spare for progeny. The remainder of the first section deals with the mechanics of managing your portfolio--monitoring and rebalancing it--how to, the frequency, and logic.
The second portion of the book concentrates on financial advice--determining if you need it, where to get
it and the questions you should ask to assess the quality of the potential advisor. Having reviewed your assets and determining your preference for an asset allocation, you should be prepared for any questions that the advisor might ask you. Regarding the questions you should ask him or her:
"What is your education and professional background?
What is your management style and philosophy? What is the best investing decision you've make in the last five years? the worst?
How are fees set?
Do you prefer one type of investment over another?
Have you had success with clients similar to me? What has your past performance been for clients with financial objectives similar to mine?
How will you help me define my investment objectives? Will you provide a customized investment plan? How often will you review my portfolio?
Where will my assets be held?
Schwab recommends that you consider only fee-based managers. Check the fine print : Form ADV (Application for Investment Advisor Registration), required for all investment advisors who manage more than $25 million in customer assets, a registration of the SEC. Needless to say, communication with the advisor, reading and understanding all documents, openness and trust are key.
The book ends with a discussion about insurance--life, term, medical, disability, and long-term care--estate planning, and charitable giving.
**********************************************************
Schwab, C.2001. You're Fifty--Now what? Investing for the second half of your life. New York: Crown Business.
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