The Permanent Portfolio, Investing, Finance and Random Thoughts.
Archive for February, 2010
Complicated costs. Simple saves.
2 years ago
by Craig Rowland
in Investing
I was going through some old investing books today getting ready to dispose of them to make room on my shelves. When paging through the candidates for removal, I saw so many complicated investing strategies. Some of the portfolio recommendations held 10 or more different mutual funds as part of their allocations! I bought these books early in my investment career and during that time they convinced me that only a complicated investment strategy could deliver diversification and performance.
Boy, was I wrong.
After looking back over the many years when I first bought these books it showed me this: Despite the complexity of these various strategies, not a single one of them added anything significant to investor diversification over this time. Owning a bunch of stock funds does not make you diversified. If anything, these approaches were tremendously risky for what you got out of them. Yet, the approaches hid those risks by making you think you had diversification because you owned so many different stock assets.
Well, stocks share the same market risks by and large because of the deep interconnections that exist between them all. Just because an investor owns some small company stocks, large company stocks, foreign stocks, etc. is no guarantee that a bad bear market can’t come up and bite them all at once. I didn’t go back and run the performance numbers, but my quick look predicts that over the period I owned the books they wouldn’t have done any better than a simpler portfolio. With the additional trading and management costs involved, there is a chance they did worse than a simpler approach.
This just reminded me how important it is to keep investing simple. Complicated investment schemes can hide many risks and expenses. The simpler you keep investing, the less chance you have of making a mistake. Investors don’t need to follow complicated investment plans to get good results. Indeed, I’ve found the simpler you keep investing the more likely you are to turn a good profit and not face any wicked surprises.
Why I own stocks…
2 years ago
by Craig Rowland
in Investing
After 2008 many people swore off stocks. “Too Risky!” they say and then tell you about their hot new investment in a multi-level marketing scheme or their Uncle’s new franchise opportunity. Isn’t it funny how whatever assets you don’t own you always think are “too risky” when someone else owns them? I’m as guilty as the next guy on this. For instance, I don’t touch junk bonds and emerging market debt. It’s too risky. 
But I think I can make a better case for this position than people who don’t own any stocks for the same reason.
I own stocks and I admit it. I feel comfortable with stocks in my portfolio because they represent an ownership stake in the productive capacity of my country. Every time someone buys a Coca Cola, a computer or any other product they hand me money through the profits. When I’m awake they are handing me money. When I’m asleep they are handing me money. They are handing me this money 24 hours a day and seven days a week across the planet as they make their purchases.
Stocks have risks. Sometimes these risks show up in big price declines. But sometimes these risks cause the prices to climb far higher and faster than any other asset you can own. Over time, stock dividends reinvested can grow capital by large amounts through compounding. This makes it different than assets like gold which cannot grow on its own as it pays no dividends.
While market risks can impact a company’s stock over a period of time, I also realize that most companies are resilient and can adapt to changing economic conditions and survive. Not all of them can do this, but most do. This is why I own a broadly based stock index fund. Such a fund may own over 5,000 individual company stocks. This means any one of company going bankrupt has an insignificant impact on the entire portfolio. Not only this, but stock index funds are cheap. Every penny an investor saves in management fees is another penny in their pocket each year to compound and grow.
I know the markets have proven to be efficient over time. This means it’s almost impossible to outperform the market averages as everyone else on the planet receives the same information you do almost instantly. I recognize that sometimes the markets are not 100% efficient all the time. But I also recognize that it’s close enough that debating the point is academic because rebalancing between assets eliminates these risks.
I admit that all the brokerage houses receive news of major events within seconds and have computers and people that will trade positions just as fast in reaction to it. Therefore, I don’t try to compete with these people by out trading them because someone like me is always the last to know. Instead, I just hold on to my boring index fund that owns everything and profit from the thrashing the professional and amateur traders are doing underneath. Over time, my index fund will beat in excess of 95% of all of them.
The markets are random. The price movements are not predictable day-to-day or even each year so I balance my stock ownership with assets like bonds, gold and cash. I don’t own just stocks because owning 100% in stocks is extremely risky and not guaranteed to bring any more success than a diversified portfolio. I know there have been protracted decade-plus stretches where stocks have performed poorly in real terms (such as the 1970s and 2000s). Therefore, I reject the idea that stocks are the only asset any investor needs. Instead, I diversify just in case the next decade of under-performance happens to be during a period of time when it could hurt me.
I understand that portfolios which do not have any stock exposure face the risk that they will not be able to grow faster than inflation over time. So I accept that stocks have risks of loss in order to ensure I have the chance to take advantage of gains when they present themselves to grow my money. Although assets like gold and bonds by themselves are useful to diversify against certain market risks, I know they may not be enough to beat inflation and grow the portfolio alone. That’s why I own stocks.
Why I own gold…
2 years ago
by Craig Rowland
in Investing
Why do people freak out so much when you tell them you own some gold in your portfolio? It’s as if you had just told them you killed a dozen people before lunch. The hyper-ventilation you hear from some when you even mention this topic is just nutty. It usually starts with some juvenile comment involving tinfoil hats. Then they pull out some quote from an economist (usually one that loves inflation to solve all problems) about how useless gold is. They may even hit you with the ol’ “gold is not a form of wealth but just a shiny metal” lecture (ignoring the bulk of human history, and all major central banks, that disagree with them). Then they tell you how “risky” gold is when their own portfolio may be loaded to the hilt with junk bonds, emerging market debt or other complicated investment products. They must think the Nigerian stocks they hold in their Frontier Market fund are a sure thing (assuming they even know what’s in the funds they own).
Well, I own gold and I admit it. I feel comfortable owning gold in my portfolio. I sleep well at night knowing I own gold even though it could drop in value. I understand that in a balanced portfolio gold is a useful tool. I trust gold to protect me in high inflation more than indexed linked bonds (TIPS) ever will.
Gold has no interest or dividends. I admit these things and acknowledge that this is one area that makes gold different than stocks and bonds. However, this does not make gold useless for diversification.
Gold maintains real purchasing power over time and it’s really good at doing this. No other asset on this planet has such a long history. I don’t worry about politicians printing trillions of dollars of gold. This is because politicians can’t print gold. Gold can also be owned directly without any obligations attached to it. These are unique attributes for an asset class when used properly in a portfolio (and properly does not mean 100% gold).
While gold does not have the interest or dividends of stocks and bonds, it has other benefits that can work at certain times to protect a portfolio that does hold stocks and bonds. Gold for instance does very well under high inflation when stocks and bonds do not.
Gold has risks just as stocks and bonds have risks. I understand what these risks are and how they fit in a diversified portfolio. Yet, I do not rely only on gold in a portfolio. I also own stocks and bonds to drive returns when gold is performing poorly. In diversification there is safety which is why I own all these assets and don’t get religious about it. I accept gold’s quirks because I know when it comes time for it to perform it will do so better than all its contemporaries.
The empirical evidence says that owning some gold in a portfolio is not the death sentence academic literature would suggest. In fact, at certain times having gold can be a tremendous help. So, either reality is wrong or the academic theories are. Given a choice between the two, I’ll take reality. That reality is that all portfolios should hold some gold for diversification against stocks and bonds despite what critics state. That’s why I own gold.
