ITA Wealth Management

Over the last few weeks I note that we are picking up new readers and there has been an explosion in readership from outside the United States.  With nearly 500 entries on the free side of the blog and another 170 over on Premium Content, where does one begin to gain an understanding of the investment philosophy behind the asset allocation strategy.

The obvious and best starting place is to go back to Valentine’s Day (February 14) of 2008.  That is when I started posting investing information.  If you don’t wish to start at the very beginning, at least you are not ready to do that right now, then mover over to “Categories” and click on “Beginning Investors.”  This will get you started.  Then do a search from Fama, French, Hebner, Bernstein, or Ibbotson.  Such searches will bring up a number of entries that are fundamental to this approach to investing.

Serious investors will look up some of the books I recommend.  Authors such as Bernstein, Gibson, Ferri, and Hebner are critical.  Over under “Links” you will find a link to a long list of books to consider.  Also identified are a number you can easily skip.

I am a strong advocate of saving as much as you can as early as you can.  Develop a plan for your portfolio and that plan should center around the concept of asset allocation.  Many examples are given and the Premium Content goes into more depth of both construction and management of the portfolio.  Learn what it means to rebalance.  While we stress using ETFs for valid reasons, we will use some individual stocks.

I want to extend a special welcome to readers from Poland, Hong Kong, Dubay, Italy, South Africa, Spain, New Zealand, Australia, Canada, Russia, United Kingdom, European Union, Japan, Malaysia, India, Viet Nam, Singapore, Turkey, as well as many cities here in the United States.  Thank you for checking in on this blog.  We appreciate your readership.

Lowell Herr

Photograph: Art hanging above a garage in Central Oregon.

Why use the principles of asset allocation when constructing a portfolio?  The logic for this approach is based on research done by Ibbotson & Associates and many others.  Look up Ibbotson on this blog for more information.  We skew or tilt the portfolio toward the value side of the market spectrum as value tends to outperform growth over the long run.  Fama & French have studies that back this position.  Personal experience also supports this conclusion.

If one needs more supporting proof as to the advantages of asset allocation, I highly recommend skeptics begin reading my five top investment books.  Some readers will be won over to the asset allocation argument quickly, while for others it may take years.

Lowell Herr

Photograph:  Wetlands in Ocean City, Maryland

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After watching Part I of Bill Moyers interview of Andrew J. Bacevich, I was going to put off this post until the weekend. Then I watched Part II and decided this is too important to put off a few more days. I missed this PBS program on Friday night, but picked it off the Internet this afternoon. It is one of the most important and gripping interviews I’ve seen in a long time. Do not miss it and be sure to pass the URL on to anyone you know on the net.

Mr. Bacevich is the author of “The Limits of Power: The End of American Exceptionalism.”

Lowell

Photograph: Istanbul, Turkey

Investors interested in digging deeper into the nuances of asset allocation will find the following five books of interest. Here is my list of the five best books on asset allocation.

• The Four Pillars of Investing: Lessons for Building a Winning Portfolio
• Asset Allocation: Balancing Financial Risk
• Index Funds: The 12-Step Program for Active Investors
• All About Asset Allocation: The Easy Way To Get Started
• The Intelligent Asset Allocator

William Bernstein, of Oregon, is the author of my number one and number five picks. Actually, The Intelligent Asset Allocator is my favorite, but I would not recommend it as the first to read as the others are better for readers not as familiar with the asset allocation language. Begin your journey with The Four Pillars.

Roger C. Gibson, in his Asset Allocation (number two pick) book does a remarkable job of showing why one should build a diversified portfolio. However, I am still waiting for an author who will provide compelling data for using over ten different asset classes.

Mark T. Hebner provides one of the best overviews for passive or index investing. In his Index Funds book, Hebner goes into the history and research for this approach to investing. If cost is an issue, this book is a best buy. I also recommend visiting the IFA web site as it is one of the very best available. I provide a link off to the right under “Links.”

Richard A. Ferri, in his All About Asset Allocation book, fulfills the goals of the book title. Ferri supports our contention that a portfolio should be tilted toward the value side of the market spectrum. In this book you will learn why asset allocation is the most important investment decision you will make.

The Intelligent Asset Allocator is one of my all-time favorite investing books. Complete your summer, fall, and winter reading with this book. Bernstein has a writing style that will leave you smiling despite the challenging material.

If anyone has a favorite book on asset allocation, please add it to this list under the comments section. Your contributions are most welcome.

PS  The trial offer for subscribing to Premium Content will extend through tomorrow, 8/8/2008.

Lowell Herr

Photograph: Lima, Peru students taking a snack break.

In the forward of Robert Arnott’s new book, “The Fundamental Index: A Better Way to Invest,” Harry Markowitz poses this argument.

“Suppose we have four companies, each with $1 in reported earnings. Suppose two of these have ample future growth prospect that would justify a price 20 times the current profits, or $20, and the other two have less impressive prospects and fully deserve $10 — 10 times the current earnings. But, no one can have a clear view of the future prospects of our companies, so the market merely guesses at these fair values. Suppose the market does a pretty good job, but misjudges those prospects by 20 percent in each of the four cases, with one growth stock priced 20 percent too high and one 20 percent too low, and likewise for the value stocks. So, we have two stocks with a true value of $20 each, priced at $24 and $16, and two stocks with a true value of $10, priced at $12 and $8.”

This is not hard to follow so far. Markowitz goes on to make the argument as to why value portfolios perform better than cap-weighted portfolios.

“Suppose prices revert to fair value in the next year. The “cap-weighted” portfolio produces zero return; since the prices are symmetric around value, the errors cancel. If we could construct a fair-value-weighted portfolio, few would disagree that it should be better than capitalization weighting. It is. Half of our portfolio rises 25 percent in value, and half loses 16.7%, for an average of 4.2 percent return. Why? Because the fair value portfolio puts equal amounts in over- and undervalued stocks, while capitalization weighting put 60 percent of our money in the overvalued and 40 percent in the undervalued companies.”

“Since we have no idea what the fair value is for each company, and so there’s no way for us to construct this fair-value-weighted portfolio, why should we care that fair value weighting beats capitalization weighting? What of the other construction methods? The portfolios weighted equally and by company profits (efficiency -weighted), which lead to the same weighting in this example, produce a return of 4.2 percent also, identically the same as the fair-value-weighted portfolio!”

Take time to pencil out the Markowitz argument above.

Lowell Herr

Photograph: Lightening over Portland, OR — Image by David Vernier

“Beating the Market, 3 Months as a Time” is the title of Gerald and Marvin Appel’s new book. The thesis of the book can be explained in a few paragraphs and it goes like this.

“Once every three months, you should select from among the best-performing ETFs from the last quarter to hold in your portfolio for the coming quarter.” That is the key Appel & Appel idea. One selects two ETFs from five basic equity investment styles and they are as follows. I am including the Vanguard equivalent.

• U.S. large-cap value (VTV)
• U.S large-cap growth (VUG)
• U.S. small-cap value (VBR)
• U.S. small-cap growth (VBK)
• International (VEU)

Of interest would be data that included mid-cap value and mid-cap growth, REITs, and emerging markets. Then invest in three or four of the nine best performing ETFs. Yes, it is a little more complicated, but not a significant complication.

Lowell Herr

Photograph: Overlooking the Sacred Valley of Peru out to the Andes to the west.

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