allocation

[tenative]

Retired at 52, work part-time, wife is disabled and retired last year and is 54.
Our assets are in Vanguard mutual funds. Current allocation is 25%-stocks
50% bonds
25% cash
Is this a good allocation for conservative investors?

 

[brewer12345]

I would strongly encourage you to find a way to hedge your inflation risk. I would dump as much of the cash as you don't need for actual liquidity as you can into I-bonds. I would also seriously consider a 10% or so allocation to commodities.

 

[yakers]

I agree with Brewer. If you were an older retiree I would not worry so much about inflation but you could have 40+ years of drawing on your resources and inflation could get particularly nasty in the near future. The 25% stock should help over time but 25% cash is a bit high and not as safely productive as it could be. The bond % looks good but having the right mix of bonds is important too. Just my 2 cents. Other asset classes like commodities could be of interest, I do not have any currently but I am still in accumulation mode. And I own my house.

 

[Gone4Good]

I agree with the other posters that you need some inflation protection and I Bonds are an excellent choice.

However, I'll be the contrarian here and advise you to skip the commodities - if for no other reason than you described yourself as a conservative investor. Commodities can be extremely volatile and are now trading at historically high valuations. They seem to be the flavor of the month on these boards because they have generated great returns over the past few years, but you know what they say about past performance.

 

[tenative]

Thanks.
We own the house, no mortgage. About 20% of the bond portfolio is in I Bonds. What is your suggestion  regarding investing in commodities?  I have been a long term mutual fund and stock investor only. Commodities seem to risky?

 

[Gone4Good]

What is your suggestion  regarding investing in commodities?  I have been a long term mutual fund and stock investor only. Commodities seem to risky?

My suggestion on commodities is don't do it!

I don't think they are necessary for a diversified portfolio. Depending on the commodity investment they offer dubious inflation protection. They are at extreme valuations. And they can be very volatile.

Leave commodities to the fast money guys.

 

[tenative]

Sorry, yrs to go, I was typing while you were. Do you think Inflation Indexed Bonds purchased thru Vanguard is as good an investment as a direct purchase from the government? (I Bonds)

 

[Gone4Good]

Sorry, yrs to go, I was typing while you were. Do you think I Bonds purchased thru Vanguard is as good an investment as a direct purchase from the government?

I Bonds through Vanguard? Are you talking about the Vanguard inflation protected fund or are you talking about buying TIPS through Vanguard as a broker? Personally I think I'd just stick with I Bonds and / or TIPS bought directly from the government. I'm not sure how much value a manager adds to a portfolio of TIPS, so why pay the fee.

 

[tenative]

Thats what we have Inflation Indexed Bond Fund thru Vanguard. Also have some I Bonds purchased direct. So, it seems even with Vanguards low fees and easy access it is still better to purchase direct? Why? besides the costs?

 

[Gone4Good]

Just cost, which isn't much but I don't know what you're getting for your money. Vanguard charges 0.17% for its Inflation Indexed bond fund where the only choice the manager has to make is whether he should have a duration of 6.5 or 5.4 or something else. The fund also generates capital gains which add to the after tax cost of the fund.

By contrast Vanguard charges just 0.22% for its High Yield fund where security selection is (or should be) more rigorous and investors (should) benefit from professional management and diversification. In the case of the HY fund, 0.22% makes sense. For inflation protected securities, probably not.

If I already owned it I don't think I'd necessarily sell it to save a few fractions of pennies on the dollar though.

 

[Spanky]

Thats what we have Inflation Indexed Bond Fund thru Vanguard. Also have some I Bonds purchased direct. So, it seems even with Vanguards low fees and easy access it is still better to purchase direct? Why? besides the costs?

The return is similar (fixed plus yield) . Vanguard's TIPS fund pays out the fixed and inflation adjustment portions on a quarterly basis while IBonds are tax-deferred. For a taxable account, IBonds are better.

 

[brewer12345]

My suggestion on commodities is don't do it! 

I don't think they are necessary for a diversified portfolio.  Depending on the commodity investment they offer dubious inflation protection.  They are at extreme valuations.  And they can be very volatile.

Leave commodities to the fast money guys. 

Yrs, have you read any of the research on this, or are you just talking out of your rear end?

I don't hold a position in commodity futures as speculation or to follow momentum. I do it because all of the research I have read shows that the DJ-AIG Commodity Index is negatively correlated wit both stocks and bonds, yet has roughly similar return and volatility to equities over the long term. In particular, the index tends to do well when inflation is picking up, which is exactly the time when stocks and bonds are taking a beating. If you have a heavy fixed income weighting, commodities are an even better choice bacause your biggest risk is a pick-up in inflation.

 

[wildcat]

No offense Yrs to go but my guess is that you are talking out of your rear end. I tried to explain a little bit about the benefits of holding something like Pimco Comm Real Return but it didn't do much good.

You totally contradicted your statement. Commodities are for a diversified port b/c it is an asset class that does not traditionally move with stocks/bonds. Extreme valuations? Where did that come from? Every graph I see points to a 20-30 yr bear market for commodities. At least back your claims so others can see your point and so others can benefit. If not, some commodity exposure for diversification purposes is an excellent idea.

 

[Gone4Good]

Commodities as an inflation hedge.  Lets take gold which is widely considered a "store of value."  Here is some data calculating what your returns would be if you purchased gold at various times over the past 30 years.  I start with 1975 only because Bloomberg data doesn't go back any farther than that.  So here is the average annual return you would have realized if you bought gold at the following dates and held it to the beginning of this year:

Year Purchased            Nominal Return to '05              Real Return
1975                                 2.9%                                (1.5%)
1980                                (1.8%)                               (5.3%)
1985                                 1.4%                                (1.5%)
1990                                 0.6%                                (2.1%)
1995                                 0.7%                                (1.7%)
2000                                 8.6%                                 6.0%

Hardly what I would call a bulwark against inflation.  Stocks have done better, Inflation protected securities (if they were available) would have done better, and my guess is that regular old treasuries would have done better too.

A 20-30 yr bear market in gold or soy beans or pork belly futures doesn't, in and of itself, make these things any more intrinsically valuable.  These are not stocks that continue to reinvest and grow.  A lump of gold today is the same exact thing as a lump of gold was 30 years ago - only now we've developed new materials to replace its limited usage as an industrial material.

I agree that commodities can diversify a portfolio.  But what I said is that they "are not necessary" for a diversified portfolio.  These two statements are not mutually exclusive.  Art, comic books, stamps, wine, rare coins and antiques can all diversify a portfolio too - so what?

I continue to be amazed by the full throttled acceleration to buy commodities NOW after the tear they've been on.  It strikes me funny that the same people I know who were buying Rhythms Net Connections 6 years ago are buying oil futures now.  And everyone claims its for "diversification.  In a recent thread on REITS the common theme was "I'm selling my REIT exposure."  I guess diversification has its limitations.

Besides, Tentative described himself as a "conservative investor."  He can diversify into emerging markets stocks too - but I doubt it is the right investment for a "conservative investor".

 

[Gone4Good]

Yrs, have you read any of the research on this, or are you just talking out of your rear end?

I do it because all of the research I have read shows that the DJ-AIG Commodity Index is negatively correlated wit both stocks and bonds, yet has roughly similar return and volatility to equities over the long term. 

Interesting.  Did any of your "research" inform you that the DJ-AIG was launched on July 1998?  Seven years of data, most of which has included the current run up in commodities!  Wow!  Color me stupid for not seeing the long-run historic significance of this.

Dow Jones cobbled together "estimated" DJ-AIG data from as "early" as 1991.  From January 1991 to May 2000 the "estimated" DJ-AIG returned a whopping 0% nominal.  That's right.  Zip, zero, nada - less inflation of course.  The DJ-AIG is an inflation hedge, right? 

Since May 2000, however, it has returned an average annualized nominal return of 11.7%. 

Gee, I wonder why everyone is all of a sudden interested in commodity "diversification."

As for having the "a similar return as stocks" - did your "research" inform you that the DJ-AIG "estimated" data shows an average annual nominal return from 1991-2005 of just 3.5%?  My stocks did better than that.  My bonds too.

Look.  It's your portfolio - do what you want.  But you might think about the risk tolerance of your audience before you recommend an investment strategy that might not be suitable for someone else.

 

[ats5g]

I'll just point out this:

Facts and Fantasies about Commodity Futures

Abstract:
We construct an equally-weighted index of commodity futures monthly returns over the period between July of 1959 and December of 2004 in order to study simple properties of commodity futures as an asset class. Fully-collateralized commodity futures have historically offered the same return and Sharpe ratio as equities. While the risk premium on commodity futures is essentially the same as equities, commodity futures returns are negatively correlated with equity returns and bond returns. The negative correlation between commodity futures and the other asset classes is due, in significant part, to different behavior over the business cycle. In addition, commodity futures are positively correlated with inflation, unexpected inflation, and changes in expected inflation.

I think the "big deal with commodities" is that they do well when stocks and bonds do poorly. Hence the good diversification.

- Alec

 

[Nords]

I think the "big deal with commodities" is that they do well when stocks and bonds do poorly. Hence the good diversification.

I thought commodities (including gold & other precious metals) were just a hedge against a declining dollar.

Until recently, inflation was rising faster than the dollar was declining.

 

[brewer12345]

I'll just point out this:

Facts and Fantasies about Commodity Futures

I think the "big deal with commodities" is that they do well when stocks and bonds do poorly. Hence the good diversification.

- Alec

Ding ding ding!!! We have a winner. Yrs, you are missing the most important part of what the research says: a diversified portfolio of fully collateralized commodity futures is NEGATIVELY CORRELATED with stock and bond futures while having about the same risk premium and volatility as equities. Negatively correlated means that the futures portfolio does well when stock and bond returns are lousy, and vice versa. It is as close to a free lunch as exists in the world of investing and finance.

Take a few minutes and read the research raddr has done and cobbled together. He says it a lot more eloquently than I can: http://raddr-pages.com/research/CommodityFutures.htm

I find the research sufficiently convincing to maintain a minimum of 10% of my portfolio in PCRDX. If I ever choose to have a heavier bond allocation, that percentage will rise.

 

[markplus4]

I like precious metal stocks, particularly copper. True, it's at a record high but it's been stubbornly hanging out at those levels for quite a while. While a short term correction is entirely possible, maybe even likely, I love the long term fundamentals. Sometimes it "really is different this time"....with the emerging industrialization of China/India, et. al, I think it will continue to do well. Basic supply/demand.

 

[Dawg52]

When a discussion is started concerning asset allocation, I assume it to mean allocation of your assets over the long haul. At least thats the way I look at it. Who knows, maybe commodity prices are high right now but I am very comfortable in having it as a piece of my portfolio. I own I-bonds, a REIT fund, stock funds, bond funds, cd's......all part of a diversified portfolio. How much you allocate to each depends on your age and comfort level. As Unclemick says, there is more than one way to skin a cat. You just have to figure out which is the best way for you. 

 

[bosco]

Ding ding ding!!! We have a winner. Yrs, you are missing the most important part of what the research says: a diversified portfolio of fully collateralized commodity futures is NEGATIVELY CORRELATED with stock and bond futures while having about the same risk premium and volatility as equities. Negatively correlated means that the futures portfolio does well when stock and bond returns are lousy, and vice versa. It is as close to a free lunch as exists in the world of investing and finance.

Take a few minutes and read the research raddr has done and cobbled together. He says it a lot more eloquently than I can: http://raddr-pages.com/research/CommodityFutures.htm

I find the research sufficiently convincing to maintain a minimum of 10% of my portfolio in PCRDX. If I ever choose to have a heavier bond allocation, that percentage will rise.

hmmm....from looking at this graph of PCRDX versus S&P, it seems that there may be some negative correlation on a short-term basis which would smooth out short-term volatility. But it's far from obvious that this will result in the kind of long-term hedge that people are hoping for.

 

[brewer12345]

That's because all the studies use decades worth of data. Your chart shows, what, a couple of years? Not statistically significant.

 

[Gone4Good]

brewer,
I've read the research.  I am, however, highly skeptical of research produced by people trying to sell me something (e.g. Greer/PIMCO).  The research also runs contrary to my understanding of how futures work (they are not insurance products) and my observations (most commodities under perform inflation for long periods of time), which only increases my skepticism. 

Greer completely dismisses the traditional “cost of carry” model for pricing futures contracts without so much as an explanation.  He constructs an elaborate example around cattle futures, but does not explain why the constraints in that market should apply to metals, agriculture, and energy. 

If the cost of carry model holds, then the interest accrued from “collateralization” simply compensates for the cost of carry imbedded in the futures contract.  Buying a 1 year forward contract for gold and buying an equivalent notional amount of 1 year treasuries should yield the same result as buying the gold outright.  Any other outcome means arbitrage profits are available for the taking. 

I’ve read other research suggesting that long-dated futures contracts do have some “insurance premium” built in because of a lopsided market for sellers and buyers.  The research focused on trading strategies to extract that premium.  I can only assume that whatever premium existed in the past, if one ever existed at all, is rapidly being arbitraged away. 

In any event, these sources of returns over and above the return generated by the underlying commodity must be pretty generous to offset the horrible inflation adjusted returns of commodities (as shown below).  Greer says they are, but I can't prove / observe that.

Here are some examples of commodity performance for your viewing pleasure:

In all cases the white line is the commodity and the green line is the CPI index.  The differing time periods reflect the limitations of Bloomberg's historic data.


1) Gold

2) Copper  (would have been better off burying your cash in mason jars)

3) Soy beans (not any better)

4) Oil (energy commodities are the only ones that seem to track inflation well)

5) Here is a comparison of the S&P 500, 30-Year Treasury Bond and DJAIG

Good luck to everyone!

 

[brewer12345]

Only problem with all those pretty charts is that they don't actually include:

A) the DJAIG plus tips returns, and

B) any environmennts other than generally falling interest rates and inflation.

A more detailed rebuttal will have to wait fort a time when I'm not holding a squirming toddler.

 

[wabmester]

A more detailed rebuttal will have to wait fort a time when I'm not holding a squirming toddler.

I can vouch for brewer. This is not a cop-out. Those little buggers are cute, but they strictly enforce a 2-minute attention span for anybody in the room house.