Scott Burns: Simplicity and low expenses usually wins
A 50/50 mix of the total U.S. stock market and an Inflation Protected Securities index is likely to work well for investors who understand that simplicity and low expenses are likely to beat complexity and high expenses.
Q: You mention six to 10 asset classes that will cover most peoples’ needs. What are they?
Matching asset classes to specific mutual funds or exchange-traded funds and their tickers is often more challenging than it should be.
Also, determining the integrity of the specific fund/ETF to its stated purpose is not always as simple as it sounds. I have had my account with “Chuck” — Charles Schwab, since 1993 — but favor Vanguard funds, as does my wife.
A: There are six fundamental asset classes: domestic, international and emerging-markets stocks, and domestic, international and emerging-markets bonds.
According to the Dimensional Fund Advisors Matrix Book, which shows investment returns over many time periods, U.S. equities accounted for 46 percent of all market value at the end of 2012.
The rest of the developed world accounted for 39 percent. Emerging markets accounted for 14 percent. Another 1 percent is not considered “investable.”
The global debt market can be divided in the same way.
Needless to say, there are many ways to slice these broad asset classes into smaller, but still large, segments with different risk and return properties.
Real estate is an additional asset class that has been shown to reduce risk and raise portfolio returns. You can also divide stocks into small capitalization and large capitalization or growth and value.
And when you buy the S&P 500, index studies indicate that about 43 percent of revenue and nearly half of profits come from outside the United States — so you are already an international investor when you buy the U.S. stock market.
That’s one reason a 50/50 mix of the total U.S. stock market and an Inflation Protected Securities index is likely to work well for investors who understand that simplicity and low expenses are likely to beat complexity and high expenses.
Q: I am in the process of creating a balanced portfolio. The bond portion of it would be sizable. I am worried about the loss I would incur as the Federal Reserve stops buying bonds and interest rates go up. I am reticent to avoid bonds completely, but ... any suggestions?
A: You’re not alone. With the recent uptick in interest rates, many investors have experienced actual losses for the first time in many, many years.
Many people don’t understand that bond prices move in the opposite direction of interest rates. They also don’t understand that the longer the maturity of a bond, the more it will gain or lose when interest rates change.
The only way to avoid this risk is to move to funds or securities that have shorter maturities. For the extremely worried, the best path is to move out of bonds altogether and into cash. Either way, your interest income is going to go down, perhaps disappear.
Copyright, 2013, Universal Press Syndicate