Mutual fund money flows, which are a good indicator of overall retail investor market views, have been strongly negative in recent months. Global and international equity funds have experienced greater negative money flows than domestic US mutual funds this year. Until the 2008 market drops, US equity funds received lower money inflows than global and international funds.

Representative US equity funds include:

SPY, IVV, IWB, IWV, TMW, IYY, and VTI

Representative international and global equity funds include:

EFA, VEA, EEM, VWO, VEU and VT.

The data for the following charts is taken from Investment Company Institute publications.

click images to enlarge

Average Monthly Flows

3-Month Moving Average Flows

Aggregate Annual Flows

Richard Shaw
QVM Group LLC

Asset allocation is important to reduce risk.  Approximately 90% of portfolio total return comes from the asset classes you select and the relative weights you give them.

The word “never” is a dangerous term to use, particularly with respect to investing, but we believe it is probably safe to say that an allocated portfolio will never return as much as the best performing asset class, and it will never perform as badly as the worst performing class.

The important assumption is that an allocated portfolio is “expected” over the long-term to produce the blended mean return of the asset classes in the portfolio, and to do so with less volatility and less extreme draw-downs than the more volatile classes in the portfolio.

Unrealistic Expectations:

“Expected” is a tricky operative term.  We always ask new clients to indicate what returns they expect from their portfolio.  The answers are often way out of line with practical potential.  One reason for unrealistic expectations is memory of bubble years, while another may simply be inadequate information. This article is intended to deal with the information aspect of expectations.

Time Frame:

The largest issue with expectations may be the historical time window you use to develop a view.  Some periods create higher expectations than others. We think you need to study the long-term and worst periods, as well as recent periods and current trends to make sure that you understand how things may turn out.

Simple Allocation Example:

Let’s look at one very simple asset allocation (not a recommendation — just an illustration) to see how different time periods support different expectations.

A 60% S&P 500 / 40% Lehman Aggregate Bonds allocation is a classic moderately aggressive balanced portfolio allocation — balance with an equity bias.

That allocation is a popular one, such that Vanguard has offered a balanced fund on that simple allocation formula since 1986 (symbol VBINX).

US Stock/US Bonds as a Personal Risk Tolerance Yardstick:

While we would recommend more than two asset classes in a well constructed portfolio, we think that studying various combinations of S&P 500 (proxy SPY or IVV) and Lehman Aggregate Bonds (proxy AGG or BND) is a useful way to begin thinking about the mix of equity and fixed income assets that is suitable for you — particularly as it relates to risk and your risk tolerance.

You can diversify assets beyond this simple yardstick in a variety of ways with other US equity and fixed income categories, foreign varieties of equity and fixed income, and with other asset types such as real assets, commodities and cash.

In any event, we think being familiar with the characteristics of a spectrum of US equity and fixed income is important as a starting point for developing perspective on return opportunities and risks.

Weekly Short-Term Allocation Results Online:

Each week we update a short-term view of eleven blends (e.g. 90/10 through 10/90) of the S&P 500 and Lehman Aggregate Bonds yardstick on our website.

Very Long-Term 60/40 (81 years):

Vanguard published the long-term returns, best year and worst year, as well as the frequency of down years for several allocation ratios, including 60/40 from 1926 through 2006.

Their study determined the average return to be 8.9% with the worst year down nearly 27% in 1931, the best year up nearly 37% in 1933 (two years later), and down years approximately 1 in 4 years.

click images to enlarge

Short-Term 60/40 (1-wk, 4-wk, 13-wk, 26-wk, 52-wk):

Our short-term monitor of the 60/40 allocation (along with ten other US stock / US bond allocations) reveals more than a 22% decline for a rolling 52-week period.  That, not surprisingly, is near the worst experience in 1931.

If history slightly mimics itself, the long-term picture may hold out hope for a recovery of 30% or more in 2010.  Unfortunately, future history isn’t quite so predictable as past history is certain.

A $1,000,000 portfolio as of 12/31/2007 in a 60/40 allocation would be worth about $780,000 today.  A 30% recovery, would put the portfolio at about $1,014,000.

Long-Term 60/40 (22 years 1986-2007):

Twenty two years isn’t as long as 81 years, but it does span a lot of territory and is more closely aligned with the kind of globalization of trade we experience today than the 81 year history.

Our table below shows the 22 years from 1986 through 2007 to be a kinder time than the 81-year history in terms of frequency of down years (approximately 1 in 5), with a much less severe wost year (-9.16% versus -24.7%), and a higher annualized rate of return (10.17% versus 8.9%).

Sadly, that return was not available for all other starting years.  For example, a 60/40 allocation initiated at the beginning of 2000 returned only 4.03% through 2007.  The good news, and to the point of allocation, is that a 100% S&P 500 allocation made at the same time, returned only 1.68%.

The 100% S&P 500 allocation had only 1 in 5 down years from 1986-2007, but the worst down year was -22.10% as opposed to the -9.16% worst year for the 60/40 allocation.

Stock vs Bonds vs 60/40 Blend 1986-2007

The S&P data is shown in yellow highlight.  The Aggregate Bond and 60/40 data are shown in yellow, pink or green depending on their value.  Yellow indicates the value equals the S&P 500 value. Pink indicates the value is worse than the S&P value, while green indicates the value is better than the S&P value.

But Extend One Year and See Quite a Different Story (1986-2008):

If for the sake of illustration, we treat the current 2008 market results as calendar year 2008, we see even more clearly how important the time window selected is for creating return expectations.

The 22 years from 1986 through 2007 is nearly the same length of time as the 23 years from 1986 through 2008, but what a different story.

A 60/40 allocation initiated in 1986 and held for 23 years through today produced a 8.53% return (remarkably similar to the 8.9% of the 81 years from 1926-2006).  It experienced 5 down years out of 23 years overall (~ 1 in 4.5 years).  The worst year was -21.82%, much closer to the 81 year worst of -24.7% than the -9.16% for the 22 years from 1986-2007.

What a difference one year makes in setting up expectations!

Stock vs Bonds vs 60/40 Blend 1986-2008 (11/10/08)

Reality Check on Our Prior Advice:

About two years ago (01/02/07) Seeking Alpha published one of our blog posts titled, “Realistic Expectations for Returns Going Forward“.  We were probably a bit too optimistic in the upper end of a possible range, but we were definitely cautioning against too much optimism in the face of a bubbly emerging market.

A central theme was the difficulty of consistently beating benchmarks in successive years without some down years, and the limits of performance by even the recognized best institutional managers.

Back then we said;

The reality of plausible long-term returns, consistent with likely investor behavior in the face of down periods, is not as great as many would think. Most investors can’t take the pain of staying in during thick and thin. Consequently, they get out too late in down legs, and stay timid too long and miss important parts of up legs. The result is performance below their benchmark.

There are the shooting stars each year that double or more, and if we could pick those correctly and never make bad choices, we could become rich beyond imagination. The problem is that it doesn’t happen.

Look at the most celebrated current mutual fund manager Bill Miller. He exceeded his 15-year (1991-2005) S&P 500 benchmark average 12.7 % with his 15-year Legg Mason Value Trust [LMVTX] portfolio average of 16.4%. Very impressive, but almost nobody has done that with such consistency. Others have done better in terms of total return, but not necessarily by exceeding the benchmark in each discreet year.

Looking more broadly …”World’s Best Money Managers” … for large-cap US equity (roughly the same category as the S&P 500), as published by Nelson’s (part of Thomson Financial). These results include institutional portfolios, such as pension funds and separate accounts, as well as mutual funds.

… the average 10-year (1996-2005) performance of the top 40 managers was 14.95% versus Bill Miller’s 10-year 17.57% average. There were 3 of the top 40 managers who did better than Miller with returns of 18.05%, 22.67% and 26.97% (Capital Management Associates, Warwick Capital Management and Hillman Capital Management, in that order).

Certainly, managers mandated to work in a particular region, style or sector could have long excess return streaks, but their mandate won’t let them get out of the way when the cycle turns against them. And, apparently managers with broad mandates have not been able to do too much more than about 15% on average over the last 10 or so years according to Thomson Financial.

In summary, the US market produced a recent 10-year return in the vicinity of 10%, and the best money managers with broad mandates have produced returns in the range of 13% to 18% over the same recent 10-year period.

We would conclude that unless you are a major risk taker, a minor genius, and incredibly consistent, you should plan on a range of 9% to 15% with a tendency toward 10% for your own investments.

Harvard, Yale and Princeton Endowments:

Top university endowments have billions in assets, cadre’s of full-time analysts, pick of the cream of the crop in institutional advisors, access to asset classes not available to any but the very-rich and institutions — far more resources and options than almost anyone reading this article will ever have.

How have they done? What can their results tell us about realistic expectations?

The headline story for this week’s Barron’s, “Crash Course” was about how even the best endowments have been kicked in the stomach by the current market.  This year will go a long way to bring their long-term results back toward “normal”.

The article pointed to 10-year trailing returns (as of June 30) for Harvard, Yale and Princeton as 13.8%, 16.3%, 14.2%.  They said the average endowment has returns of about 6% for the 10-year period versus 3% for the S&P 500.

Barron’s speculates that, since June 30, endowment returns may have been in the range of minus 25%.  If that were so, the 10-year returns of the Ivies, might be something like 11+% to 13.5+% as of 12/31/2008.

Conclusion:

Diversify asset classes in any long-term portfolio design.

Look at multiple short-term, long-term and very long-term periods before setting up expectations.

Be aware of current trends and things coming down the track when setting up short-term expectations.

Be realistic about potential returns, and whether you can endure the volatility and maximum draw-down years associated with the return you wish to achieve.

If you expect long-term returns in the 10+% range, be prepared for a volatile ride in riskier assets.

If you are thinking about bigger numbers, such as 12% to 15% annualized over long periods, you probably can’t get it done with just US stocks and bonds, if you can do it at all.

Richard Shaw
QVM Group LLC

The fact is that today’s stock markets were extraordinary in their strength. Emerging markets (proxy EEM) up about 20% and the S&P 500 (proxy SPY) up about 11%.

There are important positive facts to consider:

• for the past couple of weeks SPY has been trading sideways — that’s good.

• SPY went up 11% today — that’s good (although going up 11% after going down about 41% in the past 52 weeks, puts the index at about 35% down from its starting point).

• according to Bloomberg, before today, the MSCI World Index was trading at about 10.5 times trailing earnings — an historically attractive multiple.

• according to a table published by dshort.com, today’s rise in the S&P 500 was the 7th largest percentage gain since 1928 — that’s good (although dshort.com points out that almost all of the really powerful one day rallies in the past were inside bear markets that continued after the rally).

• the Fed has begun to buy commercial paper and that has allowed many corporations to borrow again, that being important to inventory build and general business activity — that’s very good.

• Governments are now accommodative and injecting much liquidity and beginning to coordinate relief — that’s good for now (although the long-term price we must pay for today’s relief is not clear).

Here are some generally positive thoughts from the press:

New York Times - Oct 28
Even as Dow Soars 11%, Skeptics Lurk

“For me, the best part about today is that the market went up in the wake of what was some really discouraging economic news,” said Stuart Schweitzer, global markets strategist at J.P. Morgan Private Bank. “When the markets go up on bad news, it holds out hope that the bad news has been digested.” …

“People are feeling much more comfortable that the financial system is stabilizing, and that allows them to focus on fundamental valuations of stocks,” said Todd Steinberg, head of equities and commodity derivatives at BNP Paribas-Americas. “The caveat to that is there is still a lot of economic issues to come.” …

… some prominent investors like Warren E. Buffett and R. Jeremy Grantham, who had been bearish in the past, have in recent days said that they think stock prices had fallen far enough for them to start buying …

“Circle today as one of those days that the fundamental issues trumped panic and fear,” said Robert J. Froehlich, vice chairman and chief investment strategist with DWS Investments. But, he added, he was not ready to declare that stocks would not fall below the closing level on Monday.

Not So Positive Information:

Our concern is how to possibly reconcile the enthusiasm shown today with the really terrible news on other fronts.

We do recognize that when markets rise in the face of bad news, that is a good sign for the market — climbing a wall of worry and all that.  However, we have so much to worry about that the wall seems too tall still.

Consider these negative points from today’s news and decide for yourself if they can coexist with a reversal from bear to bull in the stock markets.

Financial Times - Oct 28
Wall St gains strongly despite grim data

US equities soared on Tuesday … in spite of a fresh glut of grim economic data.

… swings in the S&P 500 were tightly correlated with moves in the exchange rates of the euro and dollar against the yen. That suggested widespread selling of yen positions had left traders with cash to invest in US stocks.

… The market’s late afternoon surge came even after figures showed consumer confidence slumped to a record low in October, which Ian Shepherdson, of High Frequency Economics, described as “extraordinarily awful.” Separate data showed prices of single-family homes plunged by a record percentage in August.

Business Week - Oct 28
Corporate bond rates keep rising, portend defaults

The recent decline in bank-to-bank lending rates is having no effect on corporate bonds, which continue to plunge in value — a sign that the market believes more loan defaults and a wave of bankruptcies are ahead for U.S. companies.

… market rates on corporate bonds have continued to rise compared to Treasury yields for nine straight days, said John Atkins, a fixed-income analyst at IDEAGlobal.com. This trend is hitting non-investment grade bonds, or junk bonds, the hardest, but is occurring in investment grade bonds as well.

Bloomberg - Oct 28
Emerging Market Credit Risk Signals Test for IMF’s Resources

The cost of default protection on bonds sold by 11 emerging-market nations has surged near distressed levels, triggering speculation the International Monetary Fund’s ability to bailout countries may be stretched.

…“The resources of the IMF may not be sufficient for wider bailouts if needed,” said Vivek Tawadey, head of credit strategy at BNP Paribas SA in London. “If it can’t raise the money, some of the more distressed emerging markets could end up defaulting.”

Bloomberg - Oct 28
Home Prices in 20 U.S. Cities Fell From Year Ago

House prices in 20 U.S. cities declined at the fastest pace on record as foreclosures climbed before the credit crisis deepened this month.

The S&P/Case-Shiller home-price index dropped 16.6 percent in August from a year earlier, as forecast, after a 16.3 percent decline in July. The gauge has fallen every month since January 2007, and year-over-year records began in 2001.

The decrease in property values, which helped boost sales last month to the highest level of the year, will probably intensify in coming months as the latest tightening of credit markets threatens to dry up mortgage financing. Prolonged price declines may push even more houses into foreclosure, weakening consumer spending and the economy.

“There’s still quite a bit further for prices to go down, even though the volume has probably bottomed out,” William Cheney, chief economist at John Hancock Financial Services Inc. in Boston, said in a Bloomberg Television interview. “Prices will probably find a bottom sometime next year.”

Bloomberg - Oct 28
U.S. Economy: Consumer Confidence Drops to Record Low

U.S. consumer confidence fell to the lowest level on record in October as stocks plunged and banks shut off credit, raising the risk spending will collapse.

The Conference Board’s confidence index tumbled to 38, lower than forecast and the worst reading since monthly records began in 1967, the New York-based research group said today.

Forbes - Oct 28
IMF Has So Much Umpf

The International Monetary Fund is supposed to be the world’s lender of last resort, but disturbing questions were being raised Tuesday about whether it had all the money it needed to help the world’s most troubled economies in the wake of the subprime crisis.

The IMF’s first deputy managing director, John Lipksy, said on television that if the the world’s financial problems continue to grow, “we might think about whether we would need additional resources.” He added that the IMF was discussing that possibility with its members. “For now we have record liquidity,” he said.

BBC - Oct 28
Hungary to get $25bn rescue deal

Hungary has been granted a multi-billion dollar rescue package by the IMF, the EU and the World Bank.

The deal, worth $25bn (£15.6bn;19.6 euro), is intended to help Hungary cope with the ongoing effects of the world financial crisis.

It follows similar measures taken by the IMF to prop up the economies of Ukraine and Iceland.

Forbes - Oct 28
Pakistan Urged To Take IMF Money

LONDON - Pressure is piling on Pakistan to accept financial help from the International Monetary Fund, or face a financial meltdown.

WSJ - Oct 28
Argentina’s Pension Plan Presses On, Driving Down Markets and the Peso

Argentina’s leftist government pressed forward with its controversial plan to nationalize private pension funds, laying out investment guidelines for the funds it wants to seize and lobbying Congress to approve the proposal.

Taking over the $30 billion in pension fund assets will ease the cash crunch faced by President Cristina Kirchner’s government, but it has jolted investor confidence and triggered a dollar outflow.

Bloomberg - Oct 23
China’s Home-Sales Stimulus May Fail to Protect Economic Growth

China’s measures to encourage home sales aren’t enough to stop a cooling property market from dragging down growth in the world’s fourth-largest economy, said Credit Suisse AG and Standard Chartered Bank Plc.

The government yesterday trimmed costs, including mortgage rates, taxes and down-payments, for first-home buyers.

“This is the biggest property rescue package in China’s history, but it didn’t touch the two most critical areas that are dragging down the property market — property developers’ stressed cash flows and consumers’ expectations for further price drops,” said Tao Dong, chief Asia economist at Credit Suisse in Hong Kong. “The measures won’t do the job.”

Our Take:

These news items don’t include important geopolitical issues relating to countries such as North Korea, Iran, Pakistan, and Venezuela that have the potential to cause market havoc.

This news also does not deal with rising unemployment, a likely weak Christmas retail season, probably poor Q4 earnings reports, and an entirely new team running the US government and the Treasury in January (3 months from now) with unknown and potentially surprising programs.

We certainly could be wrong, but all this doesn’t seem like were are ready to resume a sustained rise in market prices.  It’s commonly said that markets anticipate about six month in advance, but normalization of the situation seems farther than six month away to us.

SPY in October

SPY for 52 weeks

Richard Shaw
QVM Group LLC

In a recent post, we studied 82 years of price change for the S&P 500.  One of our readers commented, “I read somewhere that over 80% of all five year periods dating back to the Great Depression has seen the market ahead; over 95% for ten year periods.”

That rule of thumb isn’t wrong, but it doesn’t give a full picture. Let’s add some dimension to the statistic.

Here are two semi-log price charts showing rolling 5-yr, 10-yr and 15-yr periods for the S&P 500 (proxies SPY and IVV) from 1927, and for the MSCI EAFE (proxies EFA and VEA) from 1987.

S&P 500:

There are periods of price loss with each of the 5-yr, 10-yr and 15-yr rolling averages for the S&P 500.

click images to enlarge

S&P 500 beginning of 1927

MSCI EAFE:

EAFE is a developed markets index with a shorter history, but it is fairly highly correlated with the US markets and probably will have long-term good and bad periods at frequencies and for durations similar to the US markets.

Only the 5-year rolling average of EAFE shows price losses, but had EAFE been around during the Depression and WWII, we think it would surely have had bad spells like the ones experienced by the S&P 500.

MSCI EAFE from end of 1987

S&P 500 Five-Year Periods:

The thing about statistics is that they can often be sliced and diced to support a position, and then sliced and diced again to support a contrary position.

For example, if you inspect the weekly rolling 5-year average of the S&P 500 from 1927, you can find multiple periods of 1-year or more in length where the rolling 5-year average declined.  Some were steep and some were mild.  Some were short and some were long.

There are nearly 4,000 weekly rolling 5-year periods and about 800 of them were periods of declining values. That covered about 20% of the time — essentially validating our readers comment.

Looking at it differently, from peak-to-trough-to-recovery, for those unfortunate enough to buy at just the wrong time, more than 20% of the history is a price loss.

Remember, these are price loss periods without dividend considerations.

Price: 1932 - 1952: For example, the 5-year rolling average on January 9, 1932 was $19.18.  The index reached a low of $9.91 during 1943 (a 48% loss), but did not reach $19.18 again until December 26, 1952 (21 years from the peak). That alone is more than 20% of the history, not counting lesser loss periods in the 1970’s and early 2000’s.

Nine years after the 1943 low, the 1932 investors were whole with their nominal investment.

Dividends: 1932 - 1952: During the 21 year wait for the price to recover, total dividends were$14.86 (not including reinvestment).  That is a total return of about 2.75% as of the recovery date. The sum of risk-free Treasury Bill interest on on the initial investment for the 21 years would have been $7.26 (for a total return of about 1.55%).

If the 1932 investor had held on for 21 years, the return would have exceeded the risk-free return by about 1.2%. Not so great.

Practical Human Considerations: More importantly, it is fairly well documented most people don’t/can’t hold on during extended losses.

For example, a 65 year old in 1932 would have to stay alive until age 86 to experience price recovery; and previously received dividends would not likely be well enough remembered to be factored into the emotional part of the holding decision.

A 25 years old at 1932, would likely get married, have children, seek to buy to house, somehow not need the investment along the way, and wait until age 46 to see price recovery.  We doubt that would have happened in 1 case of a 1,000.

Mostly likely the investment would be sold before the bottom, and if reinvested would have earned less interest than the $7.26 T-Bill interest, because the investment amount would be smaller.

Emotions and behaviors are as important, if not more important, than the statistical analysis.

In real life, the 1932 investors would have been better off in bonds, considering likely behaviors.

As observers of historical results, we have the advantage of knowing the end of the story.  You don’t know the end of the story when you are in the action.  We should not impute the clarity we have looking back, when our need is to look forward.

The 1932 investor probably would have been better off with Treasury Bills or Bonds (today’s proxies SHV, BSV, BIV and BND for various maturities) when emotions and behavior are factored into the analysis.

1932 - 1952 Sub-Cycles: Then spinning the stats one more time, there were two minor 5+ year peaks and troughs of the 5-year rolling average within that 21 years from the beginning of 1932 to the end of 1952 in which an investor could have made money.

Active Management/Traders: And, of course, there were nimble folks who did quite well throughout the period of lousy rolling averages.

It’s a fact though that on average, over time, active management is a net loss game.

The average manager does not do better than the market and the drag of fees eats away at returns.

It’s also a fact that superior active managers have not been able to continue to be superior in the long-term.

Picking the manager who will be superior next year is as difficult as picking the stock that will be superior next year.  Persistence of performance is not a proven phenomenon (see Law of Small Numbers below).

Exceptional Conditions 1932 - 1952: We must point out that the great period from 1932 through 1952 included a Depression, World War II and the Korean War.

We have major economic and military issues facing us today that could have comparable depressive or elevating effects on securities values depending on outcomes, which seem uncertain at this time.

Question: Is the situation today more like 1932 or more like the 1970’s or early 2000’s?  Your answer to that is critical to your investment choices and your future.

S&P Ten Year Periods:

The rolling 10-year average declined 21% from August 28, 1937 to sometime in 1942, but did not recover to the peak price until November 10, 1951 (14 years).  That was also a long wait for emotional people who are not detached computing machines, and who do not know the history before it is written.

With dividends received (no reinvestment) the total return during the 14 year holding time would have been 4.1%.  The total risk-free return on Treasury Bills on the 1937 amount would have been about 2%.

There were also rolling periods of mild loss in the 1974-1975 period, and the 1977-1979 period.

S&P 500 Fifteen Year Periods:

The rolling 15-year average declined 17% from its peak on January 10, 1942 to a bottom sometime in 1943, but did not recover to the peak price until March 3, 1946 (4 years).

Not such a long wait that time, but do you have the ability to believe in your analysis to wait 15 years for it to prove right or wrong — probably not.

With dividends the total holding time return was 4.4%.  The alternative risk-free investment on the 1942 amount would have returned 2.6%.

If you are 65 living on investment income, you’d be a bit daft if you planned that way.

However if you are wealthy and planning to pass major assets across generations, or if you are 25 with decades of earnings and savings ahead of you, a 15-year measurement period might be OK.  (see our prior article about suitability and economic age)

Few investors could hold their conviction in the face of assets melting for long periods, which a 15-year perspective would require.

Law of Small Numbers:

One problem with this entire line of research and discussion is the Law of Small Numbers.  Yes, we have many data points, but we don’t have many market eras.

The Law of Large Numbers leads people to believe that a large sample of data is likely to be good for decision or projection purposes. That is often true — but there are Black Swans, such as we are experiencing now.

The Law of Small Numbers is often overlooked by people who do not realize that a small sample of data is not likely good for decision or projection purposes.  The Law seeks to explain the self-defeating reliance of investors (and gamblers) on a short series of data as indicative of the future.

If we begin to break an 80+ year period into eras based on bull and bear markets, or conditions external to the market, we find ourselves with a very small sample.  Reliability is probably low.

Black Swans:

A further problem with this kind of analysis is that sometimes “stuff” happens.  When conditions fall well outside of the normal probability distributions, such as the way some broad credit default swap measures were out 8 standard deviations last week — all bets are off.  “Stuff” seems to be happening now.

Past is Not Prologue:

Then there is the basic disclosure statement that the regulators require — that past performance is no guarantee of future performance.  That advice is probably particularly appropriate in our current market conditions.

Implication:

If you are in the market at the end of a long bull, you may need to ride a long bear to become whole again.  It is not necessarily true that if you can wait 5 years or 10 years that you will be OK.

Your losses in a negative scenario depend on:

• how overvalued the market is when you enter,
• how undervalued the market becomes after you enter
• how terrible economic conditions become after you enter
• what income stream you receive from your investments
• what time value losses you incur
• what inflation related purchasing power losses you incur.

The market can be a bull or bubble, and it can be a bear or a beast.

We could be receiving a visit from a beast in this now global credit crisis — but maybe not — we don’t know.

You need to interpret value, conditions and the future — not rely on comforting statistical sound bites generated by the sell side of Wall Street and mutual fund companies. They need your money.

Organizations that sell products instead of advice are conflicted.  Their interests are not fully aligned with yours.  Check the source before accepting simple rules of thumb about investing your money.

Closing Note:

Market timing is a not a good idea. Investing with a steady hand and for the long-term is a good idea.  However, standing out of the way of a train wreck is not market timing.

In Shakespeare’s “King Henry the Fourth”, Falstaff  said “The better part of valor is discretion“. That’s a thought worth considering.

Think for yourself.  Don’t bet your life savings on marketing sound bites from those who want and need to sell you an investment product for their own well being.

We think having substantially more cash than typical is a prudent thing to do if you are in a mature stage of your economic life and cannot replace lost capital with new earnings and savings.

For stock investments, history and prudence would suggest an equity income bias.

Dividends can bridge you over holding periods, even if the returns are not spectacular.

Non-dividend paying “growth” stocks may convert from positive momentum stocks to negative momentum stocks.  With no dividend support, opportunity cost due to lack of income and inflationary effects could be quite damaging

Err on the side of safety and risk reduction in these difficult and confounding times, and stay broadly diversified within any stock category. If you need income, make sure your portfolio can generate it without selling positions to obtain the funds.

Richard Shaw
QVM Group LLC

There are so many US stock ETFs, it almost makes your head spin trying to keep track of them all.  They have dramatically different levels of trading volume.

If you will be taking positions for the long-term and do not expect to be darting in and out of the market as a trader, then you will probably focus more on expense ratio and whether the fund uses index replication or representative sampling. In that case the Vanguard funds are the best choice, because they have the lowest expense ratios and use index replication or near-replication, instead of sampling.

If you have a very large portfolio with a huge “bite” size, or want maximum assurance of your ability to enter and exit quickly when you wish, you will probably focus more on trading volume.

This chart may be helpful to those with a trading approach or those with a very large “bite” size.

It is organized in outline form as Broad Market > Market-Cap > Style (Growth or Value).

click image to enlarge

If you wanted to have the most liquid positions, you would use VTI for the broad market, unless you chose IWV because of its larger number of covered companies.  You would use SPY, MDY and IWM for large-cap, mid-cap and small-cap positions (note the small gap between MDY and IWM universe).  You would use IWF, IWD, IWO and IWN for LC-G, LC-V, SC-G and SC-V.

Richard Shaw
QVM Group LLC