A Diverse Portfolio

Timothy Plett
Vice President




Everyone has heard the saying, "don't put all your eggs into one basket." Just like a recipe to a dessert, building a portfolio should contain ingredients with respective quantities. The analogy of baking a pie can be used here. Your pie is supposed to have the following:

• 1 recipe pastry for a 9 inch double crust pie
• 1/2 cup unsalted butter
• 3 tablespoons all-purpose flour
• 1/2 cup white sugar
• 1/2 cup packed brown sugar
• 1/4 cup water
• 8 Granny Smith apples - peeled, cored and sliced

Lets say you felt that you did not need the ¼ cup of water and you continue to bake your pie at the recommended temperature and time.  The timer goes off and upon removing the pie you noticed it has burnt and you find yourself asking, “Why did this happen when I did everything right?”  Well you made a mistake that investors make every day, that is by ignoring the water ingredient you left out a significant part of your successful pie.  The same thing can be represented in any person’s portfolio.  Like baking a pie, all the right ingredients in the correct quantities are needed. When building an investment portfolio imagine yourself making  your pie. Your pie should first reflect your strategy.  This means that a person who is a baby boomer may have a different investment strategy compared to a 25 year old college graduate.  Here is a look at what a diverse investment portfolio should look like:

As you can see the portfolio reflects a 70/30 ratio.  This obviously is not a Gold Standard for any portfolio.  This is a basic example of what diversification can and may look like.

It is wise to keep a portfolio that you can understand and believe in.  The lack of understanding is the biggest reason for failure in the stock market.  This means constant research and studies on organizations you feel carry a value to your fund is needed. Some investors do not believe in putting more than 10% of investments into one vehicle.  Like the picture above, int’l Large Cap Blend takes up 28% of the portfolio which in this case plays a very significant role.  This could be because the person who owns this portfolio may have a very good understanding of international markets and investments.  It is wise to invest in markets you have a good understanding in and of course you must enjoy it.

For those who feel the need to invest but do not have the time and resources to give to research and studying of markets a mutual fund may be a direction for you.  A mutual fund is a balance of several investments which pools together a group of investors to a diversified portfolio with a large sum.  An example of this is a Vanguard Mutual Fund.  Vanguard owns $1.4 trillion in assets and is a leader in collective investment schemes in the US.  This is a safe vehicle to investors with lower risk and low research requirements.  Mutual funds serve several benefits like:  diversification, economies of scale, liquidity, divisibility, and professional management.  These appeal to the simple investor looking to play in the market without having to put in a large amount of time.  Of course there is going to be fees and expenses paid out to the fund managers which could play as a set-back.  Generally organizations will charge 1-2% and sometimes sales charges as well.  These obviously would not be paid in one’s own managed fund.

Whether creating your own pie of investments or paying someone else to make one for you, the investment portfolio must be well balanced and created on a foundation that matches your own goals and needs.

Familiarity Breeds Overconfidence

It is a fact that you are more likely to bet on a sport which you are familiar with. The same holds true with investing. When investing, people are likely to invest in stocks they are familiar with, and they perceive the unknown as too risky. This common phenomena most likely explains why investors tend to stay domestic when choosing stocks for their portfolio. Are international securities riskier than U.S. securities? Not at all. If investors would make an effort to familiarize themselves with foreign companies and markets, then they would see for themselves all the potential international markets possess. Do not let lack of familiarity shy you away from investing in foreign securities. Contrary to popular belief, diversifying with foreign securities is a great way to hedge risk in your portfolio. Familiarize yourselves and go global investors!

Is this a good time to buy stocks?

Thanks Dr. Vaughan for this excellent piece on stock investing...

Those who do not remember the past are condemned to repeat it.

George Santayana

It is incumbent on every generation to pay its own debts as it goes. A principle which if acted on would save one-half the wars of the world.

Thomas Jefferson

TERRY SAVAGE
savage@suntimes.com

Q. I have a simple question for you: Is this a good time to buy stocks?


A. Ordinarily, I'd give you an equally simple answer: It's always a good time to buy stocks -- if you have a long-term perspective and are buying a diversified portfolio of stocks using a mutual fund.

That's an answer I always use to duck that question, because I truly believe that a regular program of investing is a better approach than trying to "time" the market. And I do believe that, over the long run, you want to invest in the future of America.

But today, I have a different answer. Start by looking at the chart on this page, because a picture is truly worth a thousand words (which is a few hundred more than my editor will give me).

The graphic shows the difference in results between two investors who get in and out of the market based on the presidential election cycle, going back to the 1950s.

Investor A invests in the S&P 500 at the midpoint between presidential elections, and sells out the day before the presidential election during each four-year cycle. This investor starts with $10,000. And by 2010 the portfolio is worth $235,890. And as you can see from the chart, that even includes a significant drop because of the recent bear market.

Investor B starts with the same $10,000 invested in the S&P 500. But this investor does exactly the reverse -- buying the day after a presidential election, and selling at the mid-term election. This investor's portfolio has a paltry gain over the last half century, currently worth only $10,689.

Just to make things clear: We are today about at the "midpoint" -- the point at which Investor A puts his money in the market!

Credit for this chart goes to James Stack of Investech.com, who writes a stock market newsletter that is always replete with historical information. Of all the charts and comparisons he has made over the years, this one always strikes me as the most astounding in its consistency.

Or is it astounding?

New presidents (or even those elected to a second term) try to get the tough stuff out of the way immediately after they are elected -- whether it's tax increases or controversial spending programs. That's typically bad news for the economy. But in the last two years of a presidential term, there is often more pandering to voters and more easing of credit, which typically leads to a rising stock market.

You can choose to believe in this indicator or not. I find it compelling. And if you need more reasons to be bullish right now, Stack's latest letter gives another half dozen reasons he thinks stocks will rise from current levels. For example, the low interest rates on safe government securities, such as 90-day T-bills, make stocks far more attractive than cash.

Many of Stack's technical indicators based on breadth, volume, and advances vs. declines, also are sending bullish signals. And Stack notes the rise in gold prices, which indicates a fear of inflation. But he points out that stocks have historically kept up with inflation, giving another reason to invest now as stocks are valued more realistically than gold in his viewpoint.

But the greatest bullish argument revolves around consumer sentiment -- which has been extensively pessimistic. Says Stack: "The best market gains often occur from levels of extreme pessimism."

Yes, of course, there's another side. I'll let the bears have their say, as well. But if you believe in historic cycles, the picture on this page may be worth more than a thousand words; it could be worth a lot of dollars in your retirement fund. And that's The Savage Truth.