The idiocy of cash.

[jpg7n16]

Steve-you've put your finger EXACTLY on the heart of the issue for me. The percentage of asset class, to me, actually depends on an assessment of the risk/return ratio of the vehicle.

Put another way, at what return levels to you reconsider you AA? So, let's say you have decided that 40pct corporate bonds is one AA. In what conditions do you rethink this? Hownlow would bond returns and volatility have to go for you to rethink? Bottom line, it's hard for me to divorce the idea of a general investment plan from the actual returns and risks. It seems rational to me, and yet, I get the impression people think it's a bad idea. Does it have to be?

This is much more of a bottom-up actively managed idea/mindframe.

You are first looking at the investment classes, determining what you believe their intrinsic value is (evaluating expected returns), and then after looking at the investments themselves, you evaluate what allocation that would give you.

Which for the active investor, wouldn't be an issue.


The asset allocation strategy DS is discussing has much more to do with risk tolerance, and the standard deviation of the portfolio, than a risk/return per asset class idea. The asset classes are joined together to first manage the risk level and timeframe of the portfolio. Then the expected returns are developed from current rates, given a set allocation.

[Scanner]

Yeah, I think it's fair to say I am often tredding on virgin ground (or where immortals only tread - Warren Buffet, the Immortal).

I just feel often there is a lacking of common sense in DisneySteve's/Mainstream approach, although I respect the hypothesis of efficient markets. Heck, I would say it's beyond "hypothesis" - to be honest, I would have to accept it as an axiom.

For instance, let's say DS is 50/50 equities/debts and he has let's say 25% in domestic and 25% in international with equities (to just be simple. . .stay with me). Let's say his international fund rallies 60% in one year. Well, wouldn't "common sense" tell you, at least for HIS portfolio, that he has made a good profit and he should take some BEYOND just the normal rebalancing? That is, I personally wouldn't reset to 50/50 Domestic/International. . .I would reset to a different diversified mixture. . .maybe be out of international altogether and move onto real estate or something else.

I often use the "Surfer Dude" analogy. . ."How more can you ride this wave, dude?" Time to get off and paddle back out and see if there is another set of waves coming in, no?

And to stay with the topic, when you are paddling out, that is when you are in cash for that part of your portfolio. Maybe RJ.Phila is just paddling back out right now.

(and yes, you may miss a wave if you just laid there like DisneySteve - I am not sure the Ocean is efficient - it's often irrational and an ugly beast, if you get the analogy. . .sometimes you have to dive under the waves)

[rj.phila]

great responses, guys. thanks for this. i guess another factor for me is that i get the impression that most people have an investment spectrum that kinda goes "individual stock-index fund-bond-cash", but most of their swings are really between stocks/funds and bonds. i feel like the spectrum i am working on is more like "index fund-RE-fixed income", so the rebalancing is maybe a little more....macro, if you will?

another factor for me: i dont see investing as divorced from real returns. put another way, i have a concrete goal:

to reach a passive income of ~35k after taxes with the least amount of perceived risk.

while im close to this, im not quite there. thus, when an instruments' returns swing from 6% to 1%, this is a big deal. i have an EF, and a well funded IRA. im not trying to acheive a "healthy relative return %", if you will. im trying to acheive a specific return AMOUNT. and i know that this is probably an uncommon way of looking at investing, but its just how my brain works.

[disneysteve]

So Scanner, in your surfer dude investment portfolio, how and when do you decide to take your profits and paddle back out? When do you rebalance? Do you do it annually? Semi-annually? Quarterly? Monthly? Maybe I rebalance in December and the rally in my international fund doesn't occur until the following January through March. Should I rebalance again? Seems to me that no matter how you answer that question, you could be seen as engaging in market timing. You are trying to predict when the wave has crested and when (and where) the next wave is going to swell.

As JPG said, it really comes down to a difference in philosophy. I'm a busy guy. I don't have a whole lot of time to closely monitor my holdings and make tweaks and changes regularly. I prefer to generally set things on a path and stick with it, only making periodic adjustments, usually by redirecting new contributions to even things out.

[Scanner]

So Scanner, in your surfer dude investment portfolio, how and when do you decide to take your profits and paddle back out? When do you rebalance? Do you do it annually? Semi-annually? Quarterly? Monthly?

When. . ."with a reasonable degree of medical certainty" you are sure the rally is just about over, and, AND, you have a profit you are happy with.

With ETF's, you can at least now put a bottom on rallies and secure profits at different levels. You can re-evaluate:

"Is my real estate still a good investment? Do I want to own this? Or has that wave gone ashore?"
"Is my international fund still a good investment? Do I still want to own foreign companies in Europe, Asia and S. Americ? Or has that wave gone ashore?"
"Is my silver still a good investment? Or have the nutjobs lost their mind? "

As JPG said, it really comes down to a difference in philosophy. I'm a busy guy. I don't have a whole lot of time to closely monitor my holdings and make tweaks and changes regularly. I prefer to generally set things on a path and stick with it, only making periodic adjustments, usually by redirecting new contributions to even things out.

Well, you are pretty much here everyday. . .it's not THAT much work to log into your portfolio, note a "rallying" is happening and then "re-diversify" to different sectors/elements, is it?

I am not talking about day trading like Gambler.

[Scanner]

Another thing I keep in mind - you beleive in the "Efficiency of the Markets" hypothesis. I have to often agree with this axiom.

There is another "axiom" out there with investing (probably wouldn't apply to trading) - the 7% rule.

I believe Peter Lynch forwarded this in the 80's but anyone feel to correct me if I am wrong.

The idea is up to 7% return on an investment, the risk is commensurate with reward. After 7%, for each 1% of return you get, the risk becomes non-commensurate. That is, if you go an 8% return on your international fund, it probably took too much risk. And so on. . .and so on. . .so, if your portfolio has this sudden rally, to me, it's your DUTY to sell things off and mitigate risk down.

In other words, you caught a good wave dude.

Get off.

Now, we can parse over whether 7% is still that "magic number" but as soon as any investment in my portfolio starts to exceed that, I now take a look at the "greed factor" and try to reduce it.

Is this a bad management philosophy?

[disneysteve]

When. . ."with a reasonable degree of medical certainty" you are sure the rally is just about over, and, AND, you have a profit you are happy with.

Since I don't have a crystal ball, I don't know when a rally is just about over nor do I know when one is about to begin. That's why I dollar cost average over time and rebalance periodically. Sure, you could say to sell when a fund is up 10% or 15% but I've had funds return as much as 70% in a year. Why should I miss out on that by jumping ship too early?

it's not THAT much work to log into your portfolio, note a "rallying" is happening and then "re-diversify" to different sectors/elements, is it?

The point of diversification, dollar cost averaging and rebalancing is to moderate risk and greatly reduce the need to closely monitor and track each of your holdings and the need to make buy and sell decisions on an ongoing basis.

I would disagree that identifying peaks and valleys is that simple. I don't have the time, inclination, or quite honestly, the knowledge to research various sectors and investments and decide which to buy or sell when. That's why I hire professionals to do that for me via mutual funds. In fact, that is also why a good chunk of my portfolio is in index funds, because statistically, the pros aren't so good at it either.

If one of my funds was up sharply, I'd agree that it is not likely to continue on that upward path but I have no idea when the downturn will happen. If I decided to sell, I'd also then have to identify another investment that I felt was poised for a rally. I may or may not guess correctly, which is why market timing is discouraged. I suppose one could argue that rebalancing is a form of market timing since you are either selling holdings that have outperformed or just directing new money into holdings that have underperformed, but it is done on a more systematic basis.

Every study ever done seems to show the same thing. The investors who do the best over the long haul are the ones who diversify, invest regularly over time and limit their trading. The more one attempts to time the market, the worse you are likely to do over time.

The idea is up to 7% return on an investment, the risk is commensurate with reward. After 7%, for each 1% of return you get, the risk becomes non-commensurate. That is, if you go an 8% return on your international fund, it probably took too much risk.

I've never heard that. Personally, I'd say 7% would be too low a number for that "rule" since the long term average return of the broad market is 10-12%. Had I followed the 7% rule for the past 20 years, I'd have a whole lot less money in my portfolio.

[jpg7n16]

For instance, let's say DS is 50/50 equities/debts and he has let's say 25% in domestic and 25% in international with equities (to just be simple. . .stay with me). Let's say his international fund rallies 60% in one year. Well, wouldn't "common sense" tell you, at least for HIS portfolio, that he has made a good profit and he should take some BEYOND just the normal rebalancing? That is, I personally wouldn't reset to 50/50 Domestic/International. . .I would reset to a different diversified mixture. . .maybe be out of international altogether and move onto real estate or something else.

I liken this viewpoint to the craps player who says, if the dice haven't landed on 7 8 times in a row, you should bet on a 7 coming because it's due. (mathematically, the odds are the same every time regardless of past rolls)

The assumption of your argument is that DS's international allocation was reasonably priced before, and due to a 60% increase must now be overpriced - due to 'common sense'. But you don't really know that it wasn't vastly underpriced before, and is now reasonably priced (or even still underpriced). Or that the outlook of the international economy has significantly improved, making a 60% rise in prices justified (or you could even argue that the price should have risen 80%, and thus hasn't fully reflected all the information yet).

So 'common sense' can never really say that a security is overpriced solely because the price has risen 60%.

The point is that, the EMH assumes that the market is always reasonably priced. So if it was reasonably priced 60% ago, then the value of the foreign holdings has legitimately risen by 60%.


My personal version of the EMH is that the market is frequently reasonably priced, but not always. Single securities are frequently improperly priced. The more the security is traded, the more frequently the price is reasonable. Stocks like PG or WMT are reasonable more often than not (though the not times still happen IMO). Index funds are frequently traded and therefore frequently reasonably priced.

[Scanner]

The point is that, the EMH assumes that the market is always reasonably priced. So if it was reasonably priced 60% ago, then the value of the foreign holdings has legitimately risen by 60%.

Ah, now here is the crux of the philosophical/theoretical dispute we have. I guess, now that I am cornered, do not assume that. . .that the market is "efficient" based on the 7% rule.

Okay, maybe 7% is too low. . .maybe 10% is the magic number. . .but you can go back historically, beyond 1-2 years, more like 10 years and then extrapolate where you think the market (whatever market) should be, whether that's the S&P 500, Russell 2000, oil, whatever.

That was my thesis with silver. . .that based on a normal rate of appreciation, it should be here - the upside reward potential outweighed downside risk. . .that's how I continually think about my active investment plan, rather than a faith in the efficiency of the market - that "Well, I guess a 60% return was normal. I'll just rebalance.".

I do realize though doing my strategy you won't always get the maximum squeeze out of a rally. . .very rarely in fact.

Again, not trying to sell anyone on my "method" - just food for discussion and the investor who started this thread can make a decision what works for him.

[disneysteve]

the upside reward potential outweighed downside risk. . .that's how I continually think about my active investment plan

This is really the philosophy difference: Active vs. Passive investing.

Buying index funds, dollar cost averaging and periodic rebalancing is primarily a passive method of investing. Continually evaluating current prices and values and upside potential for your investments is a much more active method of investing. In reality, most people do a blend of the two. My portfolio leans more toward the passive method though I also do own some individual stocks and some actively managed mutual funds. And I have occasionally tweaked things here and there based on whatever I thought was appropriate at the time. So I'm not opposed to either method when appropriate.

[Frugal]

I don't think cash is "stupid" at all. It is always a wise choice to have some, and not invest every last cent you have on hand, in my opinion.

[Snodog]

I personally don't like cash and only hold it in my emergency fund. Cash is a poor long term investment.

If you are concerned about higher inflation/rising rates just go with short term bonds.

Even in a rising interest rate/high inflation environment like we had from 1972-81, short term (2 year) treasuries outperformed money market 8.48% - 7.53%.

If we don't get the high inflation everyone is so certain will come then short term bonds should do even better.

As for QE2 I have no idea. I tend to think QE2 will have greater effect on the stock market than the bond market.

[essaydean]

yeah anonymous banker has some nice tricky tips but,i m gonna go with this suggestion.

[steveaz67]

take a look at the trinity study. Cash and equivalents will not last through retirement.