Don’t Get Done In By Unintended Overweight Exposure
By Roger Nusbaum, AdvisorShares ETF Strategist
A few things from around the interwebs over the weekend.
First up is a paper from Research Affiliates titled Building Portfolios: Diversification Without The Heartburn. The paper targets a portfolio with a 10% volatility, a pretty low number and because of current valuations believes the way to get there is to have only 27.5% in equities but no domestic equity exposure, just foreign. Other exposures in the mix include 5% in bank loans, 6.7% in non-dollar denominated emerging market debt, 5.3% in commodities and 7.1% in what it calls “local and foreign cash.”
With a starting point being 60/40 equities/fixed income, the proposed (theoretical?) portfolio allocates 37% to fixed income so that’s not far from 40 but takes a lot from equities to put into diversifiers. Emerging market equity gets about 2/3rd of the overall equity allocation and using iShares funds as proxies, emerging market equity has a standard deviation of 15% compared to 10% for the S&P 500 so maybe the authors are viewing EM’s standard deviation as a form of leverage, more bang for the buck although to be clear the paper doesn’t say that. While I do not doubt the heavy lifting that went into devising the portfolio, circling back to a point I’ve made repeatedly including just a few days ago, when you put too much into diversifiers you end up with a portfolio of diversifiers hedged with a little bit of equity and a poor upcapture in terms of participating in bull markets.
ETF.com posted about the extent to which some of the most popular, mega cap tech stocks have dominant weightings in many broad based ETFs such that someone could build a portfolio with several funds that seemingly cover different ground all with large weightings in the same couple of mega cap tech stocks. Someone might think buying a value fund, momentum fund, quality fund, earnings fund and dividend fund would create diversification but not necessarily.
This harkens back to the tech wreck more with traditional mutual funds where when the S&P 500 had a 30% in tech, many funds had 50%. Similar story with financials in 2007. With ETFs this is easily overcome thanks to their transparency, but the work needs to be done. There’s software/websites that can do the work for you or you can just open up a spreadsheet and do it yourself. After seeing the unintended overweight effect in 2000, I am surprised it repeated in 2007 but that then tells me it will happen again, maybe tech now or something else later. But there is no reason it needs to occur in your portfolio…as an unintended overweight. Choosing to have 40% in something will either work or it won’t but knowing you’re doing it is far better.
Sam Julien wrote a list of key concepts he learned from James Altucher. If you engage social media, you probably know who he is. Investor and investment writer turned self-help guru, turned social media star and from what I can tell his latest ventures include trading cryptocurrencies and standup comedy. Our paths crossed a little bit at theStreet.com a while back, he mentioned my blog in an early book and we have a little bit of contact through social media.
I think the way to learn from James is not necessarily to take everything he says literally (I own my house and like my work too much to quit) but he has figured out quite a few things for himself some of which is useful for many people and he continues to evolve as a person. Read Sam’s post for the full list but a couple that stood out as follows;
Have 7 income streams, not 1. Multiple Streams Of Income was a book published in 1998, I read it ages ago and the concept has been a cornerstone to many of my blog posts as this seems to be an obvious solution for many people and is the idea behind my posts about monetizing a hobby. I tweeted something from Seeking Alpha the other day that said the top 10% of households having $274,000 saved for retirement. That data point was from Blackrock and while I doubt it’s right, if it is right then there are terrible implication for the bottom 90%.
The process here is pretty straight forward and something I’ve gone through dozens of times but a couple who can come up with $250,000 in a 401k after 35-40-year careers, net $100,000 downsizing their home doesn’t have to be in terrible shape for retirement and while this scenario may not be attainable for everyone, the assumptions are far from heroic. Then layer on monetized hobbies (or failing that, part time work), another income stream, that brings a combined $1500 and these folks effectively have an additional $450,000 “portfolio” assuming the 4% rule…even if the effect only lasts for a few years.
Build a foundation of physical and mental health every day. The latest I have seen on the Fidelity study is that people retiring this year will spend $275,000 on health care expenses as retirees. For many of us this is behavioral and even people with genetic obstacles can do something to be a little more active, mentally and physically. This is something we all know we should do, exercise and remain mentally engaged, but actually doing it can be difficult.
The quality of life implications are obvious in terms of being able to walk through a museum and enjoy it (if you are into museums) or being able to stand in a full train car for 15 minutes while traveling but the financial implication is just as obvious. Quite clearly the $275,000 number is not allocated evenly at $11,000 per year for 25 years, or some other linear equation but the retiree who can make it to 75 spending only a couple of thousand/year will be better able to financially withstand the larger expenses that are more likely to come along as older retirees. Again, this is obvious but worth saying.
Finally, Country Living had an article about nine (mostly rural) places in the US that will pay people to move there. The pay for now is more along the lines of small rebates but there is free land available in a couple of places if you build a house of a certain size. This is the sort of thing that has a good chance to evolve. I mentioned a few weeks ago a road trip my wife and I took to and through New Mexico and the extent to which we saw quite a few towns that were past their respective hey days. There are towns like this all over that could benefit from some amount of influx and might be willing to offer incentives to make their towns increasingly appealing. If you’ve been reading my posts for a while you know where I am headed, people might get free land to put up houses that don’t have a minimum size like some in the article. A scenario of free land, building a tiny house (wheels or no wheels) in a downsizing situation, two hours from a fairly big city becomes a plausible solution for some people who are under saved for retirement.
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