Tax Preparation
Selwyn Gerber writes:
According to RVW Investing, the only real decision most investors need make is the portion of overall assets to place into stocks and how to allocate those assets between the different classes of stocks. Many studies have shown that more than 90% of investment returns are due to this asset allocation decision and less than 10% of the returns are related to timing and stock selection. Since timing and selection are normally not possible, asset allocation is the only factor that can impact and should be the major focus of an investment strategy. Investors must not only determine their optimum mix of stock indexes, but they must determine how much to allocate to fixed income securities. While it is arguable that a one-size-fits all portfolio of ETFs could be constructed, each investor has unique needs for cash flow and retirement planning and thus must customize his own bond exposure.
Rebalancing
While benign neglect is an important component of the RVW approach, it is actually not the most efficient way to maintain a portfolio with a more complex asset allocation. We believe you should completely ignore market moves and not worry about day-to-day variations in your portfolio value. Nevertheless, a little bit of maintenance is needed to maintain a portfolio’s equilibrium.
Over time, asset classes perform differently and your portfolio composition will drift away from the targeted allocations. It is important to buy more of the laggards and sell some of the leaders, rebalancing to bring expected performance back to the original plan. Philosophically this step assures that the investor – and not the market – determines and maintains the asset allocation within the portfolio.
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By having a well-defined asset allocation policy in place and rebalancing to maintain a steady allocation you will automatically take profits by selling when the market is euphoric and prices are high, and buy when the market is depressed and prices are low. This takes advantage of the fact that at the times of greatest optimism, future returns are likely to be low; and when things look worst, when there is blood in the streets, future returns are likely to be the highest.
Some Suggested Portfolios
As an example of these concepts, some suggested portfolios are shown in Figure 15-1. Since personal circumstances can vary dramatically, these would be rarely be the exact recommended portfolios. The bond allocation is determined by the simplistic formula of 120 minus the investor’s age.
Larger investors would take similar approaches, using more ETFs to gain exposure to more asset classes and other investments to increase possible returns. In the end, these Rip Van Winkle portfolios will provide peace of mind, lower volatility than the markets, and superior returns.
New Age Rip – Indexing for Insomniacs
After reading this work, a person would have to be in complete denial to believe that they will earn greater long-term returns by attempting to time the market or select winning stocks. That being said, many people are addicted to the market. They can’t help but to spend countless hours watching CNBC and to watch every tick on their computer screens. For such individuals, the temptation to buy and sell will be enormous. Moreover, they will have a hard time accepting market returns when they believe that they can do better by applying their own intelligence.
These market addicts are not lost for all time, destined to spend an eternity with sub market returns. Rather, they too can benefit from the power of Rip Van Winkle. Even they will not deny that a core portfolio of ETFs is a wise foundation for success. Still, they seek to quench their thirst to play market moves. This can be accomplished through trading “around” their core portfolio by making small directional bets that compliment their index portfolio on an opportunistic basis.
One example of this approach using options is “writing” or selling calls against portfolio positions. A call is an option contract whereby the buyer purchases the right to buy a security at a certain price up until some time in the future, “the expiration date.” The seller, in turn, agrees to sell the security at that price if and when the option is executed. When the seller already owns the underlying security the option is called a “covered” call.
New Age RVW Investors will sell these calls against portfolio positions. So long as these positions do not rise too quickly, the option will expire and the seller pockets the premium. If the position rises above the “strike” price, the option will be executed and the investor will be forced to sell. In essence, this strategy will work to enhance returns in markets with limited upside volatility. For the investor with insomnia, it just be the elixir to allow him the opportunity to actively participate in the market and enhance his returns without undermining his new found faith.
Long-time index investors and new converts alike, have reason to be optimistic about their financial futures. With a strategy and a disciplined implementation plan, you will avoid the mistakes that cost most others dearly in the markets. A plan will avoid the mistakes of overconfidence that can drive irrational buy and sell decisions. Bernstein recommends that you should “dare to be dull.” Excitement is best found in other areas of your life. Buying and holding low cost, market beating index funds should be boring.
Your self-discipline will be your greatest asset in investing. With a Rip Van Winkle portfolio, you will follow a plan that lets you keep your head while everyone else is losing theirs. Armed with the truth about the fees, inefficiencies and fallacies that destine typical investors to sub-market returns, you now have the power to take control of your financial future. You are now empowered to liberate yourself from the tyranny of brokers with great ideas and managers who churn your account for their own benefit.
Tags: Finances