Let us just take a quick trip to Fidelity's website to find an example. I chose the Fidelity Focused Stock Fund after rapidly clicking around the website. I notice on the very front page of this fund's mini-website is the summary. It has R squared, Morningstar ranking, spiffy chart with a comparison tool, and minimum to invest. See what you need to understand about financial service companies is that at their heart they are marketing organizations. They want to segment the consumers into groups and sell them products that they try to make attractive. Thus this page of drivel. The first 4 pages can be skipped and of course the last page, the most important page is the fees. Currently the fees are 1.20% of assets. So if you invest a Dollar they take 1.2 cents, or if you invest a 100 dollars they take a buck-twenty.
Whew, glad that is over, I can live with a buck-twenty off each year, even the years when it goes down. Wait, it is not over, I have to read the what pro-ssspppeccctusss?!? Turns out to be not so bad, that is the fees not the prospectus. No loads, or holding periods. Just your 1.20 which they have reduced to 1.0% because the annual return over the past 10 years you would have lost 0.8% of your money that you placed in the fund. See marketing.
However, this kills my point. So now I have to just tell you about the fees without a nifty example. Maybe Fidelity is not so evil. The point is that research has shown that most of these mutual funds do not beat their index after fees are incorporated. In fact, the numbers are worse because the data sets used do not track funds that die, so actual experience in aggregate for all investors would be worse. However, with the power of the Internet investors, again in aggregate, are becoming wiser and following less of the marketing jargon and following their noses to the fees and expense.
Fees, i.e. things to avoid if at all possible:
- Front-end load: rarely seen except in the annuity world. Means that you place 100 bucks with the broker and he charges 6%. Some of the money goes directly to the broker for making you purchase it and the rest goes to the company to set up your account to receive those cool prospecti
- Back-end load: The opposite of the front-end load. Cool exception though is that the fee drops the longer you hold the investment. So it may be 6% to exit in the first year but it will decline to 0% if you hold on to the fund until after 6 years. This is also popular on annuities as well.
- 12b-1 fee: named after the SEC ruling that allows them. This pays for the marketing of the fund and also defers some of the cost of the broker's commission.
- Expense Ratio: This is the cost to run the fund. For example, paying the investment manager so he can drive a Bugatti and summer in the Berkshires. Also to pay the peons in the contact center to listen to you cry about how much money you are losing. Finally it pays the fund accountants to syphon off the fees from your account into Fidelity's.
So the main point is that with the Intertubes we can find out all this information and there has been a move away from fees and loads. On the flip side of the coin there are very knowledgeable fund managers out there who can beat their index so it might be worth finding them. However, I believe it is just as difficult to find these managers as it is to pick stocks. So I index and create alpha in other ways. That being said I could not construct my portfolio in the manner that I have it without having ETFs at my disposal. So I will show my portfolio of low cost ETFs as one of the best ways to continue growing your wealth on an annual basis. I have no index I am trying to beat other than not losing money.
So here it goes. I have found or at least whittled down in an Aristotelian catalog 7 asset classes. They are Domestic Stocks, Domestic bonds, Foreign Stocks, Foreign Bonds, Commodities, Precious Metals, Cash, Domestic Real Estate, and finally Foreign Real Estate. For those of you counting at home there are 9 items on my list. Well, there are two forms of real estate but really only one class and precious metals and commodities are also real assets. Both members of the two sets behave slightly differently so I utilize them.
Some caveats.
There are ETFs for each of these classes and I chose the ones with the lowest fees. Also, I am not including other wealth here like a house you may own, or an apartment you may rent to tenants. You would have to look closely at all that makes up your net wealth to decide how much exposure you wish to have to each of these asset classes.
If you have made it this far I wish to add one more caveat. You should not be investing until you have 6 months of savings in a money market fund. Meaning, you should have enough liquid assets to last you 6 months in the case of a sickness, a job loss or a divorce. Until that is done I would suggest checking out bankrate.com and finding the highest earning savings account that is FDIC insured. When I first began I found Amtrust Direct and they offered over 5% interest on money that I could have in 48 hours if I needed it. There are others like FNBO out of Omaha and ING is a domestic bank but it has a Dutch heritage. However, because of unprecedented action by the Federal Reserve I would expect that most savings accounts will be about or under 2%. Don't worry about the relatively low rates your wealth will be expanding while a lot of people's money will be contracting. It is the real rate of interest not the nominal ones that matter. Right now the real rate is negative so even your low rate on your account is very helpful.
Domestic Stocks - IVE
Domestic Bonds - BND
Foreign Stocks - VWO
Foreign Bonds - ESD
Commodities - DBC
Precious Metals - GLD
Domestic Real Estate - IYR
Foreign Real Estate - RWX
Cash - BSV
Now the next part is finding out what weights you wish to attach to each of these categories. Obviously over the past few years being overweight cash, commodities, gold would have been wise. However, this is a long haul portfolio so allocating 100% to Gold right now not really the optimal long term solution.
Remember what I said about financial services firms, the same can be said of financial television. They just want you out there buying and selling giving them a purpose to be shouting over each other every morning. So one day it is buy China stocks, the next day it is sell those and buy Australian mining concerns, then oil, then reverse convertible bonds. Investing is boring and should be done once a year. Unfortunately, rebalancing is not sexy, that is until Serial Correlation came about.
See what I am about to say sounds dumb, but the portfolio I want is like Bernie Madoff's. He returned 9-10% a year every year no matter what happened. He had serial correlation. That is what helped expose him. I want the same, only instead of stealing from investors I just want my returns to be consistent and predictable within a range. To do that I must rebalance.
Quick example. I have a portfolio of two securities A & B and 10 bucks. I asses my risk and find that I want to have 4 dollars of A and 6 dollars of B. Well after one year A is up 100% and B is up 16.7%. So Now in my portfolio instead of the original 10 bucks broken into the 40/60 split, I now have 8 of A and 7 of B. So you must fight your intuition to leave well enough alone and at the end of the year you must rebalance. This is alpha, this is the free lunch. So you sell 2 of A and buy B so you are back to 6 & 9 or 40/60. This helps you lock in your gains.
It is an order of magnitude more difficult when you have 7 or 9 stocks to follow but it is infinitely easy to follow the logic. What happens the following year when A is down by 50%, you are at 3 but your B gained 20%. So you are better off by rebalancing than just letting it ride. At the end of year 2 you have 3 and 10.8 which is close to 14 or a loss of 8.0%. If you have just let your portfolio ride you would be at 4 and 8.4 a loss of 17.3%. Now these are small numbers, a simple example, but remember the top of the page. Never lose money, if you must do so, do so in small amounts. This is also why we want more than two assets in the portfolio.
You may lose money in any particular year on an individual stock/asset class but by diversifying in multiple asset classes and rebalancing one can minimize the losses, which have a disproportionate affect on how you will fare as an investor.
So for my portfolio here are the allocations:
Domestic Stocks - IVE - 20%
Domestic bonds - BND - 10%
Foreign Stocks - VWO - 15%
Foreign Bonds - ESD - 10%
Commodities - DBC - 10%
Precious Metals - GLD - 10%
Domestic Real Estate - IYR - 15%
Foreign Real Estate - RWX - 10%
Cash - BSV - 0% ***
Good luck!
*** Cash should be held in times of market turmoil. My economic model had me reduce my ETF holdings to cash in late 2007. I was always involved in one or more of these ETFs over the past 18 months but cash became an increasingly significant amount of my portfolio as all the asset classes became correlated and were in hindsight overpriced.
Disclaimer: I am currently long GLD
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